Project Finance with Limited Recourse

Abstract

Project finance has become an important method for financing large-scale, capital-intensive projects, such as power plants, oil pipelines, roads, tunnels, etc. We analyze debt capacity and risk choice in a project finance arrangement where the project's lenders have limited recourse to the sponsoring company's assets. We draw a parallel between vulnerable financial guarantee loans and project finance loans with limited recourse. Using contingent claims analysis, we illustrate the trade-offs between risk and debt capacity in those cases where the project's lenders have recourse to the sponsor's assets and in those where they do not.

TOPICS: Credit risk management, project finance, volatility measures