Credit Risk in a Network Economy

13 years 10 months ago

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We develop a structural model of credit risk in a network economy, where any ﬁrm can lend to any other ﬁrm, so that each ﬁrm is subject to counterparty risk either from direct borrowers or from remote ﬁrms in the network. This model takes into account the role of each ﬁrm’s cash management. We show that we can obtain a semi-closed form formula for the price of debt and equity when cash accounts are buﬀers to bankruptcy risk. As in other structural models, the strategic bankruptcy decision of shareholders drives credit spreads, and diﬀerentiates debt from equity. Cash ﬂow risk also causes credit risk interdependencies between ﬁrms. Our model applies to the case where not only ﬁnancial ﬂows but also operations are dependent across ﬁrms. We use queueing theory to obtain our semi-closed form formulae in steady state. We perform a simpliﬁed implementation of our model to the US automotive industry and show how we infer the impact on a supplier’s credit spreads...

Didier Cossin, Henry Schellhorn

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