Bank loan commitments and interest rate volatility

An economic rationale for the pricing structure of bank loan commitments

“…Pricing in turn is linked to the economic motivation for the loan commitment. Many papers model loan commitments as put options [Thakor, Hong and Greenbaum (1981), Thakor (1982) and Ho and Saunders (1982)]; some papers emphasize the role of risk aversion [for example, Campbell (1978)], and others rely on liquidity [Sealey and Heinkel (1985)] and shifts in credit risk [James (1981)]. Except for the paper by James (1981), however, there is no explanation for the pricing structure of loan commitments.…”

Loan Commitments and Monetary Policy

“…See for example Campbell (1978), Thakor, Hong and Greenbaum (1981), Thakor (1983) and more recently Boot, Thakor and Udell (1986) and Greenbaum and Berkovitch (1986). In our view, loan commitments emerge as a mechanism that allows the avoidance of rationing effects on borrowers.…”

Pricing of Loan Commitments for Facilitating Stochastic Liquidity Needs

“…1 Campbell (1978) and Thakor and Udell (1987) argue that a risk-adverse borrower is willing to pay a premium to a bank to take on the interest rate risk on its behalf. Bartter and Rendleman (1979) and Thakor et al (1981) (hereafter, THG) suggest that the potential difference between the interest rate on a committed loan and that on a comparable spot loan on the loan commitment maturity date (e.g., due to a worsening of the borrower's credit rating) creates a value to the borrower such that taking out a committed loan is similar to executing a European put option. THG have developed a continuous-time option pricing model that prices a loan commitment as an interest rate (credit) risk transfer instrument based on Merton's (1973) intertemporal capital asset pricing model.…”