The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling
AbstractThis article presents a comprehensive framework for valuing financial instruments subject to credit risk and collateralization. In particular, we focus on the impact of default dependence on asset pricing, as correlated default risk is one of the most pervasive threats to financial markets. Some well-known risky valuation models in the markets can be viewed as special cases of this framework. We introduce the concept of comvariance (or comrelation) into the area of credit risk modeling to capture the default relationship among three or more parties. Accounting for default correlations and comrelations becomes important, especially during the credit crisis. Moreover, we find that collateralization works well for financial instruments subject to bilateral credit risk, but fails for ones subject to multilateral credit risk.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 47136.
Date of creation: 01 May 2013
Date of revision:
asset pricing; credit risk modeling; unilateral; bilateral; multilateral credit risk; collateralization; comvariance; comrelation; correlation.;
Find related papers by JEL classification:
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-06-04 (All new papers)
- NEP-BAN-2013-06-04 (Banking)
- NEP-MAC-2013-06-04 (Macroeconomics)
- NEP-RMG-2013-06-04 (Risk Management)
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