Article
Version 1
Preserved in Portico This version is not peer-reviewed
The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling
Version 1
: Received: 29 September 2019 / Approved: 3 October 2019 / Online: 3 October 2019 (04:49:57 CEST)
How to cite: Xiao, T. The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling. Preprints 2019, 2019100038. https://doi.org/10.20944/preprints201910.0038.v1 Xiao, T. The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling. Preprints 2019, 2019100038. https://doi.org/10.20944/preprints201910.0038.v1
Abstract
This article presents a comprehensive framework for valuing financial instruments subject to credit risk. In particular, we focus on the impact of default dependence on asset pricing, as correlated default risk is one of the most pervasive threats in financial markets. We analyze how swap rates are affected by bilateral counterparty credit risk, and how CDS spreads depend on the trilateral credit risk of the buyer, seller, and reference entity in a contract. Moreover, we study the effect of collateralization on valuation, since the majority of OTC derivatives are collateralized. The model shows that a fully collateralized swap is risk-free, whereas a fully collateralized CDS is not equivalent to a risk-free one.
Keywords
asset pricing; credit risk modeling; unilateral; bilateral; multilateral credit risk; collateralization; comvariance; comrelation; correlation
Subject
Business, Economics and Management, Finance
Copyright: This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
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