Modeling Collateralization and Its Economic Significance

David Lee

MPRA Paper from University Library of Munich, Germany

Abstract: ABSTRACT This article presents a new model of collateralization. We study the economic impact of collateralization on the plumbing of the financial system. The model gives an integrated view of different collateral arrangements. We show that the effect of collateral on asset prices is significant. Our study shows that a poorly designed collateral agreement can actually increase credit risk. We find evidence that collateral posting regimes that are originally designed and utilized for contracts subject to bilateral credit risk (e.g., a swap) may not work properly for contracts subject to multilateral credit risk (e.g., a CDS) in the presence of default correlations. These findings contradict the prevailing beliefs in financial markets about collateralization.

Keywords: collateralization; collateral posting; credit support annex; credit risk modeling; the plumbing of financial system; derivatives valuation subject to credit risk. (search for similar items in EconPapers)
JEL-codes: G12 G17 G24 O11 O16 (search for similar items in EconPapers)
Date: 2023-09-23
New Economics Papers: this item is included in nep-ban, nep-ifn and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:118678

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