Collateralized CDS and Default Dependence -Implications for the Central Clearing-

Masaaki Fujii and Akihiko Takahashi
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Masaaki Fujii: Faculty of Economics, University of Tokyo
Akihiko Takahashi: Faculty of Economics, University of Tokyo

No CARF-F-246, CARF F-Series from Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo

Abstract: In this paper, we have studied the pricing of a continuously collateralized CDS. We have made use of the "survival measure" to derive the pricing formula in a straightforward way. As a result, we have found that there exists irremovable trace of the counter party as well as the investor in the price of CDS through their default dependence even under the perfect collateralization, although the hazard rates of the two parties are totally absent from the pricing formula. As an important implication, we have also studied the situation where the investor enters an offsetting back-to-back trade with another counter party. We have provided simple numerical examples to demonstrate the change of a fair CDS premium according to the strength of default dependence among the relevant names, and then discussed its possible implications for the risk management of the central counter parties.

Pages: 17 pages
Date: 2011-04
New Economics Papers: this item is included in nep-ban and nep-rmg
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:cfi:fseres:cf246

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