International Journal of Theoretical and Applied Finance · 2013 · 21 citations · 4 references
BusinessFinanceContract TheoryFinancial EconomicsInternational FinanceCollateral ManagementCounterparty Credit RiskCredit RiskDisposition Of CollateralArbitrage-free PricingBilateral MarginingCollateral RehypothecationCounterparty Default RiskCounterparty RiskCredit Derivatives PricingCredit Spread RiskNetting Rules
This article is concerned with the arbitrage-free valuation of bilateral counterparty risk through stochastic dynamical models when collateral is included, with possible rehypothecation. The payout of claims is modified to account for collateral margining in agreement with International Swap and Derivatives Association (ISDA) documentation. The analysis is specialized to interest-rate and credit derivatives. In particular, credit default swaps are considered to show that a perfect collateralization cannot be achieved under default correlation. Interest rate and credit spread volatilities are fully accounted for, as is the impact of re-hypothecation, collateral margining frequency, and dependencies.
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