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Collateralized CDS and Default Dependence -Implications for the Central Clearing-

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  • Masaaki Fujii

    (Faculty of Economics, University of Tokyo)

  • Akihiko Takahashi

    (Faculty of Economics, University of Tokyo)

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    Abstract

    In this paper, we have studied the pricing of a continuously collateralized CDS. We have made use of the hsurvival measureh to derive the pricing formula in a straightforward way. As a result, we have found that there exists irremovable trace of the counter party as well as the investor in the price of CDS through their default dependence even under the perfect collateralization, although the hazard rates of the two parties are totally absent from the pricing formula. As an important implication, we have also studied the situation where the investor enters an offsetting back-to-back trade with another counter party. We have provided simple numerical examples to demonstrate the change of a fair CDS premium according to the strength of default dependence among the relevant names, and then discussed its possible implications for the risk management of the central counter parties.

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    File URL: http://www.carf.e.u-tokyo.ac.jp/pdf/workingpaper/fseries/256.pdf
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    Bibliographic Info

    Paper provided by Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo in its series CARF F-Series with number CARF-F-246.

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    Length: 17 pages
    Date of creation: Apr 2011
    Date of revision:
    Handle: RePEc:cfi:fseres:cf246

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    1. P. Collin-Dufresne & R. Goldstein & J. Hugonnier, 2004. "A General Formula for Valuing Defaultable Securities," Econometrica, Econometric Society, vol. 72(5), pages 1377-1407, 09.
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