• The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling

    Author(s):
    Tim Xiao (see profile)
    Date:
    2020
    Group(s):
    Business Management
    Subject(s):
    Economics, Qualitative research--Methodology
    Item Type:
    Article
    Tag(s):
    asset pricing, credit risk modeling, collateralization, Quantitative methods
    Permanent URL:
    http://dx.doi.org/10.17613/jb8r-fk02
    Abstract:
    This article presents a comprehensive framework for valuing financial instruments subject to credit risk. In particular, we focus on the impact of default dependence on asset pricing, as correlated default risk is one of the most pervasive threats in financial markets. We analyze how swap rates are affected by bilateral counterparty credit risk, and how CDS spreads depend on the trilateral credit risk of the buyer, seller, and reference entity in a contract. Moreover, we study the effect of collateralization on valuation, since the majority of OTC derivatives are collateralized. The model shows that a fully collateralized swap is risk-free, whereas a fully collateralized CDS is not equivalent to a risk-free one.
    Metadata:
    Status:
    Published
    Last Updated:
    3 years ago
    License:
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