The inefficiency of refinancing: Why prepayment penalties are good for risky borrowers

This paper provides a theoretical analysis of the efficiency of prepayment penalties in a dynamic competitive lending model with risky borrowers and costly default. When considering improvements in the borrower's creditworthiness as one of the reasons for refinancing mortgages, we show that refinancing penalties can be welfare improving and that they can be particularly beneficial to riskier borrowers in the form of lower mortgage rates, reduced defaults, and increased availability of credit. Thus, a high concentration of prepayment penalties among the riskiest borrowers can be an outcome of efficient equilibrium in a mortgage market. We also provide empirical evidence that is consistent with the key predictions of our model.     

Multiple Ratings Model of Defaultable Term Structure

A new approach to modeling credit risk, to valuation of defaultable debt and to pricing of credit derivatives is developed. Our approach, based on the Heath, Jarrow, and Morton (1992) methodology, uses the available information about the credit spreads combined with the available information about the recovery rates to model the intensities of credit migrations between various credit ratings classes. This results in a conditionally Markovian model of credit risk. We then combine our model of credit risk with a model of interest rate risk in order to derive an arbitrage‐free model of defaultable bonds. As expected, the market price processes of interest rate risk and credit risk provide a natural connection between the actual and the martingale probabilities.     

DEFAULTABLE OPTIONS IN A MARKOVIAN INTENSITY MODEL OF CREDIT RISK

This paper is a follow‐up to “Valuation and Hedging of Defaultable Game Options in a Hazard Process Model” by the same authors. In the present paper we give user friendly assumptions ensuring that the general conditions in the previous paper are satisfied. We also give a systematic procedure to construct suitable intensity models of credit risk, and, in the Markovian case, we provide a variational inequality approach to the pre‐default pricing problem. We finally illustrate our results on a study of defaultable convertible bonds.     

Culture, freedom and economic growth: Do cultural values explain economic growth?

Economic freedom, the ability of a society to conduct business in an unfettered manner without government intrusion, is a key determinant of economic success, but national culture, too, is thought to play a significant role in shaping a nation's business environment. This article combines data from a bench-mark report, the Index of Economic Freedom, with two competing measures of national culture to posit a significant relationship between measures of culture, economic freedom, and economic growth. We discuss the implications of this relationship for business and for further academic research.     

The MARS Approach in the Verbal and Holistic Evaluation of the Negotiation Template

The negotiation template, which defines a set of potential negotiation offers, is traditionally evaluated by means of the simple additive weighting method (SAW). However, some recent research reports on the potential problems and inconsistencies in using and interpreting SAW-based scores. Thus, in this paper we consider the issue of evaluating negotiation offers when the negotiator’s preferences are expressed verbally. We present a new approach called Measuring Attractiveness near Reference Situations (MARS), which combines the algorithms of two multiple criteria decision making methods: ZAPROS and MACBETH. Applying the elements of ZAPROS allows identifying a small set of reference alternatives that consists of the best resolution levels for all the negotiation issues but one. In pair-wise comparisons of these alternatives negotiators need to evaluate trade-offs only, which means deciding which concessions are better to be made. Using the elements of MACBETH allows determining the strong interval scale based on verbal judgments defined by negotiators at the beginning of the preference elicitation process. We study in detail the legitimacy of hybridizing ZAPROS and MACBETH that differ in their philosophies of decision support as well as discuss the drawbacks of these two MCDM methods and propose some alternative solutions that make this approach applicable to supporting negotiators in the evaluation of negotiation offers. Finally, we present an example in which we indicate the differences in the negotiation offers’ scoring process conducted by means of MARS and the traditional ZAPROS and MACBETH procedures.     

Privatisation in Poland: Ten Years After

The purpose of this article is to compare economic discussion on privatisation, expected privatisation outcomes and actual results in Poland. First it discusses the privatisation of state enterprises in the broader context of the economic transformation programme designed and introduced at the end of 1989 and the beginning of 1990. It examines the choice of privatisation methods, the political economy of privatisation and the three major policy issues: pace of privatisation, sequence of privatisation and the authority to initiate and carry out privatisation. The final section compares privatisation blueprints and actual results. The appendix presents a detailed technical guide to the privatisation methods in Poland and a basic set of figures illustrating the outcome.     

Arbitrage pricing of defaultable game options with applications to convertible bonds

This paper is the first in a series that we devote to studying the problems of valuation and hedging of defaultable game options in general, and convertible corporate bonds in particular. Here, we present mathematical foundations for our overall study. Specifically, we provide several results characterizing the arbitrage price of a defaultable game option in terms of relevant Dynkin games. In addition, we provide important results regarding price decomposition of defaultable options. These general results are then specified to the case of convertible bonds, yielding in particular a decomposition of convertible bonds in an optional and a bond component.     

Up and down credit risk

This paper discusses the main modeling approaches that have been developed for handling portfolio credit derivatives, with a focus on the question of hedging. In particular, the so-called top, top down and bottom up approaches are considered. We give some mathematical insights regarding the fact that information, namely the choice of a relevant model filtration, is the major modeling issue. In this regard, we examine the notion of thinning that was recently advocated for the purpose of hedging a multi-name derivative by single-name derivatives. We then illustrate by means of numerical simulations (semi-static hedging experiments) why and when the portfolio loss process may not be a ‘sufficient statistic’ for the purpose of valuation and hedging of portfolio credit risk.