The term structure of credit spreads in project finance

Abstract

This paper finds that the term structure of credit spreads in project finance is hump-shaped. This contrasts with other types of debt, where credit risk is shown instead to increase monotonically with maturity ceteris paribus. We emphasize a number of peculiar features of project finance structures that might underlie this finding, such as high leverage decreasing over time, long-term political risk guarantees and the sequential resolution of uncertainty along project advancement stages. Our result is particularly relevant given the importance of project finance as a source of long-term capital for infrastructure especially in developing countries and has implications for risk management in the framework of Basel II. Copyright © 2007 John Wiley & Sons, Ltd.