Strategic loan modification: An options-based response to strategic default

► We model the optimal principal write-down in a loan modification. ► The barrier option closed-form model pinpoints the optimal LTV reset. ► Lender loan value is maximized, strategic default by the borrower is minimized. ► A binomial model for more complex forms of debt is also presented. ► Modifications with shared equity mitigate moral hazard and reduce strategic default.