TITLE

Synthetizing a debt guarantee: Super-replication versus utility approach

AUTHOR(S)
Jacques, Sébastien; Lai, Van Son; Soumaré, Issouf
PUB. DATE
January 2011
SOURCE
International Review of Financial Analysis;Jan2011, Vol. 20 Issue 1, p27
SOURCE TYPE
Academic Journal
DOC. TYPE
Article
ABSTRACT
Abstract: This paper compares two strategies for replicating a put option used to synthetize a debt guarantee contract. The first strategy, super-replication, while maintaining the portfolio value greater or equal to a target value, minimizes the transaction cost of replicating a debt insurance put option by using dynamic linear programming. The second strategy replicates this put option by maximizing the guarantor''s expected utility. A comparative study shows that both strategies give better results than the Leland (1985) method. If we use a risk-adjusted performance metric, the utility-based method performs best when transaction costs are relatively low. When transaction costs are relatively high, the two strategies yield similar results and still outperform Leland''s.
ACCESSION #
57860393

 

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