Choice of Collateral Currency

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

No CIRJE-F-778, CIRJE F-Series from CIRJE, Faculty of Economics, University of Tokyo

Abstract: Collateral has been used for a long time in the cash market and we have also experienced significant increase of its use as an important credit risk mitigation tool in the derivatives market for this decade. Despite its long history in the financial market, its importance for funding has been recognized relatively recently following the explosion of basis spreads in the crisis. This paper has demonstrated the impact of collateralization on derivatives pricing through its funding effects based on the actual data of swap markets. It has also shown the importance of the "choice" of collateral currency. In particular, when a contract allows multiple currencies as eligible collateral as well as its free replacement, the paper has found that the embedded "cheapest-todeliver" option can be quite valuable and significantly change the fair value of a trade. The implications of these findings for risk management have been also discussed.

Pages: 15pages
Date: 2010-12
New Economics Papers: this item is included in nep-ban, nep-mon and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (24)

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Persistent link: https://EconPapers.repec.org/RePEc:tky:fseres:2010cf778

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