This paper presents a new model for pricing over the counter (OTC) derivatives subject to collateralization. It allows for collateral posting adhering to bankruptcy laws. As such, the model can back out the market price of a collateralized contract. This framework is very useful for valuing outstanding derivatives.
Using a unique dataset, the author found empirical evidence that credit risk alone is not overly important in determining credit-related spreads. Only accounting for both collateral arrangement and credit risk can sufficiently explain unsecured credit costs. This finding suggests that failure to properly account for collateralization may result in significant mispricing of derivatives. The author also empirically gauges the impact of collateral agreements on risk measurements. The findings indicate that there are important interactions between market and credit risk.
Inhaltsverzeichnis (Table of Contents)
- Abstract
- Introduction
- Pricing Collateralized Financial Derivatives
- The Credit Support Annex (CSA)
- Types of Collateralization
- Modeling Collateralization
- Default Process
- Empirical Evidences
- The Impact of Collateralization on Swap Rate
- The Impact of Collateralization on Counterparty Credit Risk
- The Impact of Collateralization on Market Risk
- Conclusions and Discussion
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
This paper presents a new model for pricing over-the-counter (OTC) derivatives subject to collateralization, considering collateral posting adhering to bankruptcy laws. The model aims to accurately value outstanding derivatives by accounting for both credit risk and collateral arrangements. It seeks to demonstrate that failure to appropriately account for collateralization can lead to significant mispricing of derivatives.
- The impact of collateralization on derivatives pricing
- The relationship between collateralization and credit risk
- The interaction between collateralization, credit risk, and market risk
- Empirical evidence using a proprietary dataset from an investment bank
- The development of a model that characterizes the collateral process directly
Zusammenfassung der Kapitel (Chapter Summaries)
- The Introduction section outlines the significance of collateralization in the financial system and highlights the gap in existing research on its effects on valuation and risk. It discusses the limitations of previous models that address collateralization and introduces the novel model presented in this paper.
- The "Pricing Collateralized Financial Derivatives" chapter presents a new model for pricing collateralized derivatives, which accounts for collateral posting aligned with bankruptcy laws. It discusses the legal framework of collateral arrangements and the various types of collateralization: partial, over, and full. The chapter also explores the mathematical framework of the model, including default processes and the use of reduced-form models.
- The "Empirical Evidences" chapter provides empirical findings regarding the impact of collateralization on swap rates, counterparty credit risk, and market risk. It examines the influence of credit risk and collateralization on swap premium spreads, the relationship between collateralization and credit value adjustment (CVA), and the interaction between collateralization, credit risk, and value at risk (VaR).
Schlüsselwörter (Keywords)
The key words and focus topics of this paper include collateralization, asset pricing, financial system plumbing, swap premium spread, credit value adjustment (CVA), value at risk (VaR), interaction between market and credit risk, and the Credit Support Annex (CSA). This research explores the theoretical and empirical implications of collateralization in the context of OTC derivatives pricing.
- Citar trabajo
- Tim Xiao (Autor), 2020, Pricing of Collateralized Over the Counter Derivatives, Múnich, GRIN Verlag, https://www.grin.com/document/916174
