Journal of Risk

Recursive profit-and-loss sharing

Walid Mansour, Mohamed Ben Abdelhamid and Almas Heshmati


This paper develops a new financial product that allows the profit-and-loss sharing (PLS) principle to be enforced recursively in practice. A new equity-like financial product is proposed through a three-tier partnership to which a new contracting party (the risk moderator) is added to absorb the underlying risk of premature default and adjust the annual revenue to a predetermined annual cost. The financing mechanism pioneers a new type of option, dubbed the PLS option, to manage the underlying risk of revenue sharing. A dynamic capital structure methodology is developed for the valuation of the PLS option that allows for an annual adjustment of the project's revenue and recalculates the entitlements pertaining to contracting parties. Monte Carlo simulation is conducted to evaluate the project when the construction cost is deterministic and the streams of expected cashflows are stochastic. The simulation results show that the dynamic adjustment of the capital structure simultaneously endorses a recursive profit-and-loss sharing and a dynamic risk-hedging approach. Sheer evidence shows the immunization against premature default through the involvement of the risk moderator to absorb any potential loss, which is indicative of an incentive factor for the project's survival and business continuity.



Sorry, our subscription options are not loading right now

Please try again later. Get in touch with our customer services team if this issue persists.

New to View our subscription options

You need to sign in to use this feature. If you don’t have a account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here