A general framework for the benchmark pricing in a fully collateralized market

Fujii, Masaaki; Takahashi, Akihiko

doi:10.1142/s2424786316500195

Cited by 4 publications

(1 citation statement)

References 16 publications

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“…2. Equation (3.1) shows the terminal value of the derivatives contract, including the net return of collateral without the default obtained in Johannes and Sundaresan (2007), Fujii et al (2010), Takahashi (2016), andTakino (2019). Recall that this characteristic arises from the assumption of perfect and continuous collateralization.…”

Section: Pricing By Dealermentioning

confidence: 99%

The impact of non-cash collateralization on the over-the-counter derivatives markets

Takino

2021

Rev Deriv Res

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In this study, we propose a microeconomics model to verify effects of the non-cash collateralization on the liquidity of the over-the-counter (OTC) derivatives markets accepting both cash and non-cash assets. Liquidity is measured as an equilibrium volume of the derivatives contract. The equilibrium volume is obtained by solving the utility maximization problem of a risk-averse collateral payer who wants to optimize her/his capital. The collateral payer's capital depends on the non-cash asset used as collateral. We consider both option and forward contracts as examples. Our sensitivity analysis shows that the optimal combination of cash and non-cash collaterals can maximize the liquidity of derivatives. Especially for option contracts, the market requires both cash and non-cash collaterals for liquidity. The empirical result related to this finding is provided. Overall, the introduction of non-cash collateralization boosts the liquidity of derivatives contracts. We also show how the arrangements of collateralization can boost the liquidity of the OTC derivatives markets. Moreover, we demonstrate that the combination of cash and non-cash collaterals to maximize liquidity differs from that to maximize the participant's utility. This indicates that the optimal combination is not efficient in terms of Pareto criteria. KeywordsOTC derivatives markets • Counterparty risk • Non-cash collateralization • Demand-supply analysis JEL Classification G10 • G12 • G13 This work was supported by JSPS KAKENHI Grant Number 17K18219. We would like to appreciate participants at the 95th Mathematical Modeling and Data Science seminar, Finance and Insurance seminar series (Osaka University), and an anonymous reviewer of Review of Derivatives Research for helpful comments.

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Section: Pricing By Dealermentioning

confidence: 99%

The impact of non-cash collateralization on the over-the-counter derivatives markets

Takino

2021

Rev Deriv Res

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Derivative Pricing With Collateralization and Fx Market Dislocations

Moreni

Pallavicini

2017

Int. J. Theor. Appl. Finan.

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We present a general derivation of an arbitrage-free pricing framework for multiple-currency collateralized products. We include the impact on option pricing of the policy adopted to fund in foreign currency, so that we are able to price contracts with cash flows and/or collateral accounts expressed in foreign currencies inclusive of funding costs originating from dislocations in the foreign exchange market. Then, we apply these results to price cross-currency swaps under different market situations to understand how to implement a feasible curve bootstrap procedure. We present the main practical problems arising from the way the market is quoting liquid instruments: uncertainties about collateral currencies and renotioning features. We discuss the theoretical requirements to implement curve bootstrapping and the approximations usually taken to practically implement the procedure. We also provide numerical examples based on real market data.

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FX Modelling in Collateralized Markets: Foreign Measures, Basis Curves, and Pricing Formulae

Moreni

Pallavicini

2015

SSRN Journal

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We present a general derivation of the arbitrage-free pricing framework for multiplecurrency collateralized products. We include the impact on option pricing of the policy adopted to fund in foreing currency, so that we are able to price contracts with cash flows and/or collateral accounts expressed in foreign currencies inclusive of funding costs originating from dislocations in the FX market. Then, we apply these results to price cross-currency swaps under different market situations, to understand how to implement a feasible curve bootstrap procedure. We present the main practical problems arising from the way the market is quoting liquid instruments: uncertainties about collateral currencies and renotioning features. We discuss the theoretical requirements to implement curve bootstrapping and the approximations usually taken to practically implement the procedure. We also provide numerical examples based on real market data. JEL classification code: G13.

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A general framework for the benchmark pricing in a fully collateralized market

Cited by 4 publications

References 16 publications

The impact of non-cash collateralization on the over-the-counter derivatives markets

The impact of non-cash collateralization on the over-the-counter derivatives markets

Derivative Pricing With Collateralization and Fx Market Dislocations

FX Modelling in Collateralized Markets: Foreign Measures, Basis Curves, and Pricing Formulae

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