Measuring Idiosyncratic Risks In Leveraged Buyout Transactions

In this paper the authors use the contingent claims analysis model to calculate the idiosyncratic risk in leveraged buyout transactions. A decisive feature of the model is the consideration of amortization. From the model, asset value volatility and equity value volatility can be derived via a numerical procedure. For a sample of 40 leveraged buyout transactions they determine the necessary model parameters and calculate the implied idiosyncratic risk. Further they also verify the expected model sensitivities by varying the input parameters. From the reported returns to the equity investors they also calculated the sharp ratios for individual transaction levels, thereby fully incorporating the superimposed leverage risks.