Collateral Margining in Arbitrage-Free Counterparty Valuation Adjustment including Re-Hypotecation and Netting
AbstractThis 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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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1101.3926.
Date of creation: Jan 2011
Date of revision:
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Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-01-30 (All new papers)
- NEP-BAN-2011-01-30 (Banking)
- NEP-RMG-2011-01-30 (Risk Management)
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