Wang, Y; Chen, L and Zhuang, J (2023) Pricing of credit default swaps from the perspective of credit enhancement in PPP projects. Journal of Construction Engineering and Management, 149(6): 05023006, ISSN 0733-9364
Abstract
The difficulty in financing has become the primary obstacle in the process of promoting a public-private partnership (PPP). Asset securitization is a financial model that can exchange the predictable cash flow of illiquid PPP project assets with the current cash flow, and credit enhancement is crucial in this process. Different from the traditional external credit enhancement of PPP projects based on government guarantees, this paper introduces an innovative credit risk management tool, i.e., credit default swaps (CDS), into the process of asset securitization in the PPP model. In order to avoid opportunistic behavior caused by information asymmetry in the process of financial product transaction, a CDS trading contract between PPP project investors and risk management institutions based on the principal-agent theory and a flexible CDS pricing model is proposed. Through a demonstration case of the Leshan to Rongjiang Expressway in China, the volatility correlation among CDS contract default probability, pricing, and related factors, such as default limits, operation period, compensation amount, project investment return, investment return volatility, and PPP project investors' expected inputs, is obtained. The study shows that (1) appropriate CDS pricing helps to generate investors' high expected inputs and diligence with controls; (2) there is a positive correlation between the change of default limit and compensation amount, and the set value of default limit should not be too high, otherwise it may induce the increase of default probability; and (3) based on the high return on assets and moderate asset volatility of PPP projects, the probability of default of CDS contracts is low. The innovative financial mechanism developed by the principal-agent theory could enrich the credit enhancement methods in asset securities of PPP projects.
| Item Type: | Article |
|---|---|
| Uncontrolled Keywords: | credit default swaps pricing; incentive mechanism; principal-agent theory; public-private partnership project |
| Index terms: | risk management tool, China, risk management, opportunistic behaviour, partnership, pricing, return on assets, financing, information asymmetry, default, cash flow, agent, compensation, investor, guarantee |
| Subjects: | transaction economics, Geography, sociology, economic analysis, practitioner, partnership management, financial management, contract structure, financial risk, business, dispute resolution, risk assessment |
| Topics: | Organizational Design, Business Strategy, Roles and Professions, Cost Management, Geographical Context, Risk Management, Procurement, Stakeholder Management, Legal Issues |
| Descriptive scope: | 2 PC |
N.B. Descriptive scope is a count of how many of the five facets of empirical research are indicated by the words used in title, abstract and keywords. It is not intended as a judgement on the research; merely a count of the kind of word we would expect to indicate Phenomenon, Concepts, Theoretical framing, Empirical techniques, Analytical techniques. If all five are present, then a code of “5 PCTEA” will indicate this. If you feel the coding for this record is questionable, we welcome discussion around the terms we matched or the way we categorized them. The facet you would expect may not be coded, or a facet may be coded inappropriately. This can also bear on a larger question, of which facets should be treated as defining in construction management research. Please get in touch, and we will look at it. More details here