The Valuation of Government Loan Guarantees: a Theoretical and Empirical Perspective

Abstract

This study provides a model for the valuation of the benefits associated with government guarantee programs. The model generates the social value of a government loan guarantee under disequilibrium conditions that justify public investment as a second best decision rule. The social value of a loan is obtained by conditioning the benefits on the survival of the borrowing firm. An estimated hazard function captures the annual rate of benefit attrition resulting from the failure of borrowing firms. Benefit-cost indexes are generated by business class, thus providing ex ante asset allocation guidelines. Application of the model to a portfolio of loan guarantees administered by the Ontario Development Corporation indicates a positive social value under the assumed disequilibrium conditions.