Learning, timing and pricing of the option to invest with loan guarantees

48 Pages Posted: 7 Sep 2019 Last revised: 6 Feb 2022

See all articles by Pengfei Luo

Pengfei Luo

Hunan University - School of Finance and Statistics

Huamao Wang

University of Kent - Kent Business School

Zhaojun Yang

Southern University of Science and Technology - Department of Finance

Date Written: February 6, 2022

Abstract

This paper develops a dynamic model to examine the pricing and timing of borrowers' options to invest in a project by issuing guaranteed debt. Insurers face adverse selection and learn project quality from public information. Our model provides empirical predictions for high-quality borrowers: Learning alleviates adverse selection, reduces guarantee costs, and increases investment option values. These effects are more pronounced if uncertainty is higher. A separating or pooling equilibrium is reached, depending on the economic environment. Learning makes high-quality borrowers postpone investment but makes them accelerate investment if a pooling equilibrium is reached. Two guarantee mechanisms are compared.

Keywords: Real options, Alternative CDS, Asymmetric information, Bayesian learning, Signaling game.

JEL Classification: H81, D82, D83

Suggested Citation

Luo, Pengfei and Wang, Huamao and Yang, Zhaojun, Learning, timing and pricing of the option to invest with loan guarantees (February 6, 2022). Available at SSRN: https://ssrn.com/abstract=3445784 or http://dx.doi.org/10.2139/ssrn.3445784

Pengfei Luo

Hunan University - School of Finance and Statistics ( email )

Shijiachong Road 109#
Changsha, Hunan 410079
China

Huamao Wang

University of Kent - Kent Business School ( email )

Sibson Building
Canterbury, Kent CT2 7FS
United Kingdom

Zhaojun Yang (Contact Author)

Southern University of Science and Technology - Department of Finance ( email )

No 1088, Xueyuan Rd.
District of Nanshan
Shenzhen, Guangdong 518055
China

HOME PAGE: http://faculty.sustc.edu.cn/profiles/yangzj

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