Abstract
We use contingent claims analysis to evaluate portfolios of vulnerable private loan guarantees and to investigate their risk diversification properties. We find that for plausible baseline values of the parameters, the diversifiable credit risk can be eliminated in a portfolio of ten insured firms. We also show that further diversification can be achieved by an appropriate choice of insured firms' risk postures and of correlations between them and the guarantor. Our results suggest that, for high leverage cases, guarantors can do better through size portfolio diversification than by seeking cross-sector diversification.
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