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Valuation of Over-The-Counter (OTC) Derivatives with Collateralization
Title
Valuation of Over-The-Counter (OTC) Derivatives with Collateralization.
Creator
Guerrero, Leon, Yong, Jiongmin, Li, Xin, Brennan, Joseph, University of Central Florida
Abstract / Description
Collateralization in over-the-counter (OTC) derivatives markets has grown rapidly overthe past decade, and even faster in the past few years, due to the impact of the recentfinancial crisis and the particularly important attention to the counterparty credit risk in derivatives contracts. The addition of collateralization to such contracts significantly reduces the counterparty credit risk and allows to offset liabilities in case of default.We study the problem of valuation of OTC derivatives...
Show moreCollateralization in over-the-counter (OTC) derivatives markets has grown rapidly overthe past decade, and even faster in the past few years, due to the impact of the recentfinancial crisis and the particularly important attention to the counterparty credit risk in derivatives contracts. The addition of collateralization to such contracts significantly reduces the counterparty credit risk and allows to offset liabilities in case of default.We study the problem of valuation of OTC derivatives with payoff in a single currencyand with single underlying asset for the cases of zero, partial, and perfect collateralization. We assume the derivative is traded between two default-free counterparties and analyze the impact of collateralization on the fair present value of the derivative. We establish a uniform generalized derivative pricing framework for the three cases of collateralization and show how different approaches to pricing turn out to be consistent. We then generalize the results to include multi-asset and cross-currency arguments, where the underlyingand the derivative are in some domestic currency, but the collateral is posted in a foreign currency. We show that the results for the single currency, multi-asset case are consistent with those obtained for the single currency, single asset case.
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Date Issued
2013
Identifier
CFE0004855, ucf:49688
Format
Document (PDF)
PURL
http://purl.flvc.org/ucf/fd/CFE0004855