A bank loan pricing model based on recovery rate distribution

Abstract

In this paper, we propose a pricing model for a principal-equal-repayment loan that is common in Japan and present a tractable pricing formula for giving the loan an interest rate relevant to the default risk in consideration of the bank's risk tolerance. The pricing model is specified by the three important components of the term structure of default probability, the distribution of recovery rate at default, and the default risk premium that each bank can select independently. After discussion on adjustment of the assets on B/S, we compute the parameter named the B/S-aά¡usted asset-debt coverage ratio to specify the distribution of recovery rate. Moreover we present some numerical illustrations based on our model with real accounting data of Japanese non-listed companies.