Risky funding: a unified framework for counterparty and liquidity risk
We analyze the liquidity component in a derivative transaction where both counterparties can default, and the effect of a counterparty's default probability on his funding costs and benefits. The analysis shows that the value of a transaction is influenced not by the total cost of funding of a counterparty, but only by that component of the cost of funding corresponding to his bond-CDS basis spread, and this regulates which trades are possible in the market. Moreover, we find that the DVA can be represented as a funding benefit for the borrower, alternatively to the market standard that considers it a benefit coming from the borrower's own default risk.
|Date of creation:||20 May 2010|
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- Robert A. Jarrow & Stuart M. Turnbull, 2008.
"Pricing Derivatives on Financial Securities Subject to Credit Risk,"
World Scientific Book Chapters,
in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 17, pages 377-409
World Scientific Publishing Co. Pte. Ltd..
- Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
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