• A New Model for Pricing Collateralized Financial Derivatives

    Author(s):
    Tim Xiao (see profile)
    Date:
    2017
    Group(s):
    Business Management, Scholarly Communication
    Item Type:
    Article
    Tag(s):
    asset pricing, collateralization, CVA, interaction between market and credit risk, plumbing of financial system, swap premium spread, VaR
    Permanent URL:
    http://dx.doi.org/10.17613/3r16-9133
    Abstract:
    This paper presents a new model for pricing OTC derivatives subject to collateralization. It allows for collateral posting 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 arrangement 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.
    Metadata:
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    Published as:
    Journal article     Show details
    Pub. DOI:
    https://doi.org/10.3905/jod.2017.24.4.008
    Publisher:
    Pageant Media US
    Pub. Date:
    2017-5-23
    Journal:
    The Journal of Derivatives
    Volume:
    24
    Issue:
    4
    Page Range:
    8 - 20
    ISSN:
    1074-1240,2168-8524
    Status:
    Published
    Last Updated:
    4 years ago
    License:
    Attribution
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