We examine a specific portfolio credit derivative, an Asset Protection Scheme (APS), and its applicability as a tool to restore financial stability and reduce asymmetric information. As opposed to most governmental bailout packages implemented across the world recently, the APS can be a fair valued contract with an appropriate structure of incentives. Within the structural credit risk modeling framework, we apply two alternative multivariate default risk models: the classical Gaussian Merton model and a model based on Normal Inverse Gaussian (NIG) processes. Exchanging the normal factors in the Gaussian model with NIG factors adds more flexibility to the distribution of asset returns while retaining a convenient correlation structure. Using a unique data set on annual, farm level data from 1996 to 2009, we consider the Danish agricultural sector as a case study and price an APS on an agricultural loan portfolio. Moreover, we compute the economic capital for this loan portfolio with and without an APS.
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2011 International Finance and Banking Society (IFABS), 2011