HOW DO CREDIT SPREADS AFFECT RISK ALLOCATION IN PUBLIC – PRIVATE PARTNERSHIPS?
HOW DO CREDIT SPREADS AFFECT RISK ALLOCATION IN PUBLIC – PRIVATE PARTNERSHIPS?

Summary/Abstract: The impact of funding cost is an important dimension in the design of risk allocation in public–private partnerships (PPP), given the relevant leverage of project financing. However, the academic literature has paid little attention to this issue. The aim of this paper is to measure to what extent a higher cost of funding affect the choice of risk transfer by grantor governments. During the Great Recession, developing PPPs with market risk was a difficult task and high credit spreads were applied to project finance loans. This paper analyzes the optimal risk allocation in a PPP by using two models in which the government has the option to transfer availability risk or demand risk to a private partner. The paper finds that the credit spreads of project finance loans significantly affect the decisions on which type of risk should be transferred to private-sector parties when governments use PPPs.

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