Advances in Financial Leasing Mechanism Designs

Financial leasing contracts usually include specific clauses for early termination of the agreement in the event that the lessee defaults. The lessor might, therefore, not immediately ask for termination of the financial lease agreement in order to take advantage of the increment in fees accrued due to the default interest. The analysis presented in this work aims to find the conditions determining the optimal time to rescind the contract, when the arrears’ interest rate is higher than the outstanding fees’ interest rate established in the contract and when the return of alternative investments is deterministic. In this paper, we study the optimal time for advanced termination of a leasing contract to maximize the wealth of the lessor against the natural expiry of the contract. We prove that the optimal time can be found through the intersection of the instantaneous force of interest of a lessor’s credit at a certain date and the instantaneous force of interest of the opportunity cost of capital, or at the initial date or maturity date. To this end, we provide a detailed list of cases in which it is appropriate to terminate the contract or not. The problem is formulated in the case where the opportunity cost follows deterministic and semi-deterministic dynamics.