Entrepreneurial finance with equity-for-guarantee swap and idiosyncratic risk

Haomao Wang, Zhaojun Yang, Hai Zhang

Research output: Contribution to journalArticle

16 Citations (Scopus)

Abstract

We consider a risk-averse entrepreneur who invests in a project with idiosyncratic risk. In contrast to the literature, we assume the entrepreneur is unable to get a loan from a bank directly because of the low creditability of the entrepreneur and so an innovative financial contract, named equity-for-guarantee swap, is signed among a bank, an insurer, and the entrepreneur. It is shown that the new swap leads to higher leverage, which brings more diversification and tax benefits. The new swap not only solves the problems of financing constraints, but also significantly improves the welfare level of the entrepreneur. The growth of welfare level increases dramatically with risk aversion index and the volatility of idiosyncratic risk.
Original languageEnglish
Pages (from-to)863-871
Number of pages9
JournalEuropean Journal of Operational Research
Volume241
Issue number3
DOIs
Publication statusPublished - 16 Mar 2015
Externally publishedYes

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Keywords

  • finance
  • borrowing constraints
  • equity-for-guarantee swap
  • capital structure
  • cash out option

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