1. A New Model for Pricing Collateralized OTC Derivatives
- Author
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Xiao, TX, Xiao, TX, and Dr TX Xiao (BMO)
- Subjects
MetaArXiv|Social and Behavioral Sciences ,CVA ,collateralization, asset pricing, plumbing of financial system, swap premium spread, CVA, VaR, interaction between market and credit risk ,bepress|Social and Behavioral Sciences|Economics ,Arabixiv|Social and Behavioral Sciences ,education ,SocArXiv|Social and Behavioral Sciences|Economics ,collateralization ,asset pricing ,plumbing of financial system ,bepress|Social and Behavioral Sciences|Economics|Finance ,humanities ,SocArXiv|Social and Behavioral Sciences|Economics|Finance ,Arabixiv|Social and Behavioral Sciences|Economics|Finance ,MetaArXiv|Social and Behavioral Sciences|Economics ,MetaArXiv|Social and Behavioral Sciences|Economics|Finance ,interaction between market and credit risk ,bepress|Social and Behavioral Sciences ,ddc:330 ,swap premium spread ,Economics and Business Administration ,Arabixiv|Social and Behavioral Sciences|Economics ,SocArXiv|Social and Behavioral Sciences ,VaR ,health care economics and organizations - 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. Detailed at https://figshare.com/articles/A_New_Model_for_Pricing_Collateralized_OTC_Derivatives/8226545/files/22974665.pdf
- Published
- 2017