The effect of risk-free rate on deal structure of loan guarantee market

The deal structure of loan guarantee market refers to the distribution patterns of participants' behaviors, which depends on the implementation of guarantee contracts signed by the guarantor, creditor and debtor. While risk-free rate is a policy tool to regulate and control financial market, researches have not systematically examined the mechanism and effect of risk-free rate on deal structure of loan guarantee market. This paper develops a guarantee equilibrium model based on guarantor's capital structure, and finds that the change of risk-free rate will affect the deal structure of loan guarantee market. The model developed here suggests that as risk-free rate increases, the guarantor with high solvency probability (high quality guarantor) will increase their pricing, which will squeeze the benefit that debtor gained from purchasing guarantee; however, there is no impact on the guarantor with low solvency probability (low quality guarantor). As a result, high quality guarantors will exit from the market, and the reduction of high quality guarantors will thus increase the risk of the whole guarantee market. The validity of the results in this paper is well supported by the data of Chinese listed companies in 2007-2016, and therefore provides both theoretical and practical evidence to prevent the formation and evolution of risk in Chinese loan guarantee market.