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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 "survival measure" 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.cirje.e.u-tokyo.ac.jp/research/dp/2011/2011cf799.pdf
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    Bibliographic Info

    Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-799.

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    Length: 16 pages
    Date of creation: Apr 2011
    Date of revision:
    Handle: RePEc:tky:fseres:2011cf799

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    1. Michael Johannes & Suresh Sundaresan, 2007. "The Impact of Collateralization on Swap Rates," Journal of Finance, American Finance Association, vol. 62(1), pages 383-410, 02.
    2. Duffie, Darrell & Huang, Ming, 1996. " Swap Rates and Credit Quality," Journal of Finance, American Finance Association, vol. 51(3), pages 921-49, July.
    3. 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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