Collateral Margining in Arbitrage-Free Counterparty Valuation Adjustment including Re-Hypotecation and Netting

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Title: Collateral Margining in Arbitrage-Free Counterparty Valuation Adjustment including Re-Hypotecation and Netting
Authors: Brigo, D
Capponi, A
Pallavicini, A
Papatheodorou, V
Item Type: Working Paper
Abstract: This paper generalizes the framework for arbitrage-free valuation of bilateral counterparty risk to the case where collateral is included, with possible re-hypotecation. We analyze how the payout of claims is modified when collateral margining is included in agreement with current ISDA documentation. We then specialize our analysis to interest-rate swaps as underlying portfolio, and allow for mutual dependences between the default times of the investor and the counterparty and the underlying portfolio risk factors. We use arbitrage-free stochastic dynamical models, including also the effect of interest rate and credit spread volatilities. The impact of re-hypotecation, of collateral margining frequency and of dependencies on the bilateral counterparty risk adjustment is illustrated with a numerical example.
URI: http://hdl.handle.net/10044/1/52982
Copyright Statement: © 2011 The Author(s)
Keywords: q-fin.RM
q-fin.CP
q-fin.PR
60J75, 91B70
Appears in Collections:Financial Mathematics
Mathematics
Applied Mathematics and Mathematical Physics
Faculty of Natural Sciences



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