Collateral-Enhanced Default Risk
Chris Kenyon and
Andrew Green
Papers from arXiv.org
Abstract:
Changes in collateralization have been implicated in significant default (or near-default) events during the financial crisis, most notably with AIG. We have developed a framework for quantifying this effect based on moving between Merton-type and Black-Cox-type structural default models. Our framework leads to a single equation that emcompasses the range of possibilities, including collateralization remargining frequency (i.e. discrete observations). We show that increases in collateralization, by exposing entities to daily mark-to-market volatility, enhance default probability. This quantifies the well-known problem with collateral triggers. Furthermore our model can be used to quantify the degree to which central counterparties, whilst removing credit risk transmission, systematically increase default risk.
Date: 2013-02
New Economics Papers: this item is included in nep-ban and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1302.4595
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