A New Model for Pricing Collateralized Financial Derivatives

Tim Xiao

MPRA Paper from University Library of Munich, Germany

Abstract: This paper presents a new model for pricing financial derivatives subject to collateralization. It allows for collateral arrangements 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, we find empirical evidence that credit risk alone is not overly important in determining credit-related spreads. Only accounting for both collateral posting 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. We also empirically gauge the impact of collateral agreements on risk measurements. Our findings indicate that there are important interactions between market and credit risk.

Keywords: collateralization; asset pricing; plumbing of financial system; swap premium spread; CVA; VaR; interaction between market and credit risk (search for similar items in EconPapers)
JEL-codes: D46 D53 E43 G12 G13 G17 (search for similar items in EconPapers)
Date: 2017-07-01
New Economics Papers: this item is included in nep-rmg
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Citations: View citations in EconPapers (6)

Published in The Journal of Derivatives 4.24(2017): pp. 8-20

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https://mpra.ub.uni-muenchen.de/87088/1/MPRA_paper_87088.pdf original version (application/pdf)

Related works:
Working Paper: A New Model for Pricing Collateralized Financial Derivatives (2018)
Working Paper: A New Model for Pricing Collateralized Financial Derivatives (2017)
Working Paper: A New Model for Pricing Collateralized Financial Derivatives (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:87088

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