Research on Loan-to-value Ratios of Inventory Financing

Abstract

Determining appropriate loan-to-value ratios of commodity collateral can make banks mitigate credit risk of inventory financing effectively. Based on reduced-form approaches, this paper establishes a basic model on the determination of loan-to-value ratios. In this model, some factors, such as exogenous default probability, price volatility of commodity collateral, marking to market frequency and maturity time of loan, are considered synthetically, so the banks may determine the appropriate loan-to-value ratio of specific inventory financing operation to keep the level of taken risk consistent. Moreover, with the extensions for realistic implementation, this paper introduces time to capture, liquidity risk and non-zero trigger level into the basic model