The first valuation and risk measurement model created for unlisted infrastructure debt has been developed, with the release of a paper showing the valuation of illiquid infrastructure project debt, taking into account its illiquidity and the absence of market price feedback, can be done using advanced, state-of-the-art structural credit risk modelling.
The paper by EDHEC-Risk Institute is part of an ongoing research project aiming to create long-term investment benchmarks for investments in infrastructure.
EDHEC has previously said that improving investors’ access to infrastructure requires the creation of new performance measurement tools that can inform the asset allocation decisions of investors in infrastructure and help them integrate assets like infrastructure debt into their respective risk and return frameworks.
The paper proposes to address the challenges of illiquid investment performance measurement including the information scarcity of illiquid investments. Without market prices or large cash flow datasets, performance measurement is not straightforward. At the moment there is an absence of relevant performance measures.
This latest paper focuses on private project finance loans, as EDHEC says they constitute the largest proportion, by far, of illiquid infrastructure project debt, and are well-defined since Basel II.
The paper looks at the appropriate pricing models, return and risk models and defines minimum data collection requirements.
EDHEC shows that the valuation of illiquid infrastructure project debt, taking into account its illiquidity and the absence of market price feedback, can be done using advanced, state-of-the-art structural credit risk modelling, relying on a parsimonious set of empirical inputs.
Further, the data required to evaluate the performance of illiquid infrastructure project debt can provide the basis for a reporting standard for long-term investors.
Research director at EDHEC-Risk Institute in Singapore, Frederic Blanc-Brude said the model is practical and useful, for example it predicts the probability of default in infrastructure project debt as reported by Moody’s even before calibration with actual defaults or cash flow data.
Blanc-Brude said in the coming months, EDHEC will continue to implement its roadmap to create infrastructure debt investment benchmarks, which includes data collection to document and calibrate cash flow volatility and the creation of a reporting standard, which is effectively covered by the data collection requirements identified in the paper.
The paper can be accessed below