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

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  • Damiano Brigo
  • Agostino Capponi
  • Andrea Pallavicini
  • Vasileios Papatheodorou

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.

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File URL: http://arxiv.org/pdf/1101.3926
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Bibliographic Info

Paper provided by arXiv.org in its series Papers with number 1101.3926.

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Date of creation: Jan 2011
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Handle: RePEc:arx:papers:1101.3926

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Web page: http://arxiv.org/

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  1. Damiano Brigo & Mirela Predescu & Agostino Capponi, 2010. "Credit Default Swaps Liquidity modeling: A survey," Papers 1003.0889, arXiv.org, revised Mar 2010.
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Cited by:
  1. Damiano Brigo & Cristin Buescu & Massimo Morini, 2011. "Impact of the first to default time on Bilateral CVA," Papers 1106.3496, arXiv.org.
  2. Marco Bianchetti & Mattia Carlicchi, 2013. "Markets Evolution After the Credit Crunch," Papers 1301.7078, arXiv.org.
  3. Biffis, Enrico & Blake, David & Pitotti, Lorenzo & Sun, Ariel, 2011. "The cost of counterparty risk and collateralization in longevity swaps," MPRA Paper 35740, University Library of Munich, Germany.
  4. Tomasz R. Bielecki & Marek Rutkowski, 2013. "Valuation and hedging of OTC contracts with funding costs, collateralization and counterparty credit risk: Part 1," Papers 1306.4733, arXiv.org, revised Jun 2013.
  5. Vanini, Paolo, 2012. "Fiancial Innovation, Structuring and Risk Transfer," MPRA Paper 42536, University Library of Munich, Germany.
  6. Claudio Albanese & Damiano Brigo & Frank Oertel, 2011. "Restructuring Counterparty Credit Risk," Papers 1112.1607, arXiv.org, revised May 2012.
  7. Damiano Brigo & Cristin Buescu & Andrea Pallavicini & Qing Liu, 2012. "Illustrating a problem in the self-financing condition in two 2010-2011 papers on funding, collateral and discounting," Papers 1207.2316, arXiv.org, revised Jul 2012.
  8. Chris Kenyon & Richard David Kenyon, 2013. "DVA for Assets," Papers 1301.5425, arXiv.org.
  9. Tomasz R. Bielecki & Igor Cialenco & Ismail Iyigunler, 2012. "Collateralized CVA Valuation with Rating Triggers and Credit Migrations," Papers 1205.6542, arXiv.org.
  10. St\'ephane Cr\'epey & R\'emi Gerboud & Zorana Grbac & Nathalie Ngor, 2012. "Counterparty Risk and Funding: The Four Wings of the TVA," Papers 1210.5046, arXiv.org.
  11. Damiano Brigo, 2011. "Counterparty Risk FAQ: Credit VaR, PFE, CVA, DVA, Closeout, Netting, Collateral, Re-hypothecation, WWR, Basel, Funding, CCDS and Margin Lending," Papers 1111.1331, arXiv.org, revised Jun 2012.
  12. Bianchetti, Marco & Carlicchi, Mattia, 2012. "Markets Evolution After the Credit Crunch," MPRA Paper 44023, University Library of Munich, Germany.
  13. Lixin Wu, 2013. "CVA and FVA to Derivatives Trades Collateralized by Cash," Papers 1302.0465, arXiv.org.

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