Abstract
We introduce a framework that analyzes the interplay of credit risk and collateral market risk on loan pricing. That for, we decompose any loan in unsecured and secured part. We further consider explicitly the recovery process. The framework allows us to develop semi-analytical pricing formulas for loans where both the creditworthiness of the obligor and collateral value are correlated. We provide several applications to portfolio credit and collateral risk management. We apply the model in particular to a mortgage loan portfolio which is exposed to changing aircraft noise risk. Finally, we derive a skewed loan pricing surface in terms of the distance-to-default and distance-to-loss variables, i.e. variables which are expressed in the fundamental ex-ante known loan contract variables.
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