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Rehypothecation dilemma: Impact of collateral rehypothecation on derivative prices under bilateral counterparty credit risk

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  • Sakurai, Yuji
  • Uchida, Yoshihiko

Abstract

Rehypothecation is the practice where a derivatives dealer reuses collateral posted from its end user in over-the-counter (OTC) derivatives markets. Although rehypothecation benefits the end user through cost reduction of derivative trades, it also creates additional counterparty credit risk since the end user may not receive the collateral back when the dealer suddenly defaults. To evaluate the benefits and risks of rehypothecation, we propose a derivative pricing framework with bilateral counterparty credit risk that determines the amount of rehypothecable collateral. We also model the realistic features of derivative trades: two different types of collateral, the time delay of collateral posting and the rating-dependent collateral agreement. We apply our pricing framework to cross currency swaps and investigate the impact of rehypothecation on the swap spreads.

Suggested Citation

  • Sakurai, Yuji & Uchida, Yoshihiko, 2014. "Rehypothecation dilemma: Impact of collateral rehypothecation on derivative prices under bilateral counterparty credit risk," Journal of Banking & Finance, Elsevier, vol. 48(C), pages 361-373.
  • Handle: RePEc:eee:jbfina:v:48:y:2014:i:c:p:361-373
    DOI: 10.1016/j.jbankfin.2013.11.024
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    References listed on IDEAS

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    Cited by:

    1. Ravi Kashyap, 2021. "Behavioural Bias Benefits: Beating Benchmarks By Bundling Bouncy Baskets," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 61(3), pages 4885-4921, September.
    2. Ravi Kashyap, 2019. "Concepts, Components and Collections of Trading Strategies and Market Color," Papers 1910.02144, arXiv.org, revised Jan 2020.
    3. J. C. Arismendi-Zambrano & Vladimir Belitsky & Vinicius Amorim Sobreiro & Herbert Kimura, 2020. "The Implications of Tail Dependency Measures for Counterparty Credit Risk Pricing," Economics Department Working Paper Series n306-20.pdf, Department of Economics, National University of Ireland - Maynooth.
    4. Wang, Lei & Li, Shouwei & Chen, Tingqiang, 2019. "Investor behavior, information disclosure strategy and counterparty credit risk contagion," Chaos, Solitons & Fractals, Elsevier, vol. 119(C), pages 37-49.
    5. Ravi Kashyap, 2021. "Behavioral Bias Benefits: Beating Benchmarks By Bundling Bouncy Baskets," Papers 2109.03740, arXiv.org.

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    More about this item

    Keywords

    Shadow banking; Collateral segregation; Credit rating migration; Margin call;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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