Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)
On the Pricing of Performance Sensitive Debt
(), Tor Åge Myklebust
() and Svein-Arne Persson
Abstract: Performance sensitive debt (PSD) contracts link a loan's
interest rate to a measure of the borrower's credit relevant performance,
e.g., if the borrower becomes less credit worthy, the interest rate
increases according to a predetermined schedule. We derive and empirically
test a pricing model for PSD contracts and find that interest increasing
contracts are priced reflecting a substantial risk of shocks to borrower
credit quality. Borrowers using such contracts are of an overall higher
credit quality compared to borrowers using interest decreasing contracts.
These contracts are priced as if no risk of shocks to borrower credit
quality is present.
Keywords: Performance sensitive debt; cash flow ratios; credit ratings; (follow links to similar papers)
JEL-Codes: G12; G32; (follow links to similar papers)
69 pages, March 31, 2011, Revised May 7, 2012
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