A New Model for Pricing Collateralized OTC Derivatives

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.

Identifier
DOI https://doi.org/10.17026/dans-za7-rjzk
PID https://nbn-resolving.org/urn:nbn:nl:ui:13-md-3hvt
Related Identifier https://doi.org/10.3905/jod.2017.24.4.008
Metadata Access https://easy.dans.knaw.nl/oai?verb=GetRecord&metadataPrefix=oai_datacite&identifier=oai:easy.dans.knaw.nl:easy-dataset:178781
Provenance
Creator Xiao, TX ORCID logo
Publisher Journal of Derivatives
Contributor Xiao, TX; Dr TX Xiao (BMO)
Publication Year 2020
Rights info:eu-repo/semantics/openAccess; License: http://creativecommons.org/licenses/by/4.0; http://creativecommons.org/licenses/by/4.0
OpenAccess true
Representation
Language English
Resource Type Text
Format application/pdf
Discipline Economics; Social and Behavioural Sciences