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CCPs, Central Clearing, CSA, Credit Collateral and Funding Costs Valuation FAQ: Re-hypothecation, CVA, Closeout, Netting, WWR, Gap-Risk, Initial and Variation Margins, Multiple Discount Curves, FVA?

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  • Damiano Brigo
  • Andrea Pallavicini

Abstract

We present a dialogue on Funding Costs and Counterparty Credit Risk modeling, inclusive of collateral, wrong way risk, gap risk and possible Central Clearing implementation through CCPs. This framework is important following the fact that derivatives valuation and risk analysis has moved from exotic derivatives managed on simple single asset classes to simple derivatives embedding the new or previously neglected types of complex and interconnected nonlinear risks we address here. This dialogue is the continuation of the "Counterparty Risk, Collateral and Funding FAQ" by Brigo (2011). In this dialogue we focus more on funding costs for the hedging strategy of a portfolio of trades, on the non-linearities emerging from assuming borrowing and lending rates to be different, on the resulting aggregation-dependent valuation process and its operational challenges, on the implications of the onset of central clearing, on the macro and micro effects on valuation and risk of the onset of CCPs, on initial and variation margins impact on valuation, and on multiple discount curves. Through questions and answers (Q&A) between a senior expert and a junior colleague, and by referring to the growing body of literature on the subject, we present a unified view of valuation (and risk) that takes all such aspects into account.

Suggested Citation

  • Damiano Brigo & Andrea Pallavicini, 2013. "CCPs, Central Clearing, CSA, Credit Collateral and Funding Costs Valuation FAQ: Re-hypothecation, CVA, Closeout, Netting, WWR, Gap-Risk, Initial and Variation Margins, Multiple Discount Curves, FVA?," Papers 1312.0128, arXiv.org, revised Dec 2013.
  • Handle: RePEc:arx:papers:1312.0128
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    References listed on IDEAS

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    1. C. F. Lo & H. C. Lee & C. H. Hui, 2003. "A simple approach for pricing barrier options with time-dependent parameters," Quantitative Finance, Taylor & Francis Journals, vol. 3(2), pages 98-107.
    2. N. Moreni & A. Pallavicini, 2014. "Parsimonious HJM modelling for multiple yield curve dynamics," Quantitative Finance, Taylor & Francis Journals, vol. 14(2), pages 199-210, February.
    3. Claudio Albanese & Damiano Brigo & Frank Oertel, 2013. "Restructuring Counterparty Credit Risk," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(02), pages 1-29.
    4. Michael Pykhtin & Dan Rosen, 2010. "Pricing counterparty risk at the trade level and CVA allocations," Finance and Economics Discussion Series 2010-10, Board of Governors of the Federal Reserve System (U.S.).
    5. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    6. Andrea Pallavicini & Damiano Brigo, 2013. "Interest-Rate Modelling in Collateralized Markets: Multiple curves, credit-liquidity effects, CCPs," Papers 1304.1397, arXiv.org.
    7. Marco, Bianchetti, 2011. "The Zeeman Effect in Finance: Libor Spectroscopy and Basis Risk Management," MPRA Paper 42247, University Library of Munich, Germany, revised 27 Oct 2012.
    8. Jones, E Philip & Mason, Scott P & Rosenfeld, Eric, 1984. " Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 611-625, July.
    9. Fries, Christian P., 2010. "Discounting Revisited. Valuations under Funding Costs, Counterparty Risk and Collateralization," MPRA Paper 23082, University Library of Munich, Germany, revised 30 May 2010.
    10. Andrea Pallavicini & Daniele Perini & Damiano Brigo, 2012. "Funding, Collateral and Hedging: uncovering the mechanics and the subtleties of funding valuation adjustments," Papers 1210.3811, arXiv.org, revised Dec 2012.
    11. Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 59-117, January.
    12. Adrian Blundell-Wignall & Paul Atkinson, 2010. "Thinking beyond Basel III: Necessary Solutions for Capital and Liquidity," OECD Journal: Financial Market Trends, OECD Publishing, vol. 2010(1), pages 9-33.
    13. Duffie, Darrell & Huang, Ming, 1996. " Swap Rates and Credit Quality," Journal of Finance, American Finance Association, vol. 51(3), pages 921-949, July.
    14. Henrard, Marc, 2007. "The irony in the derivatives discounting," MPRA Paper 3115, University Library of Munich, Germany.
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    1. Damiano Brigo & Andrea Pallavicini, 2014. "CCP Cleared or Bilateral CSA Trades with Initial/Variation Margins under credit, funding and wrong-way risks: A Unified Valuation Approach," Papers 1401.3994, arXiv.org.

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