The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling

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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 (search for similar items in EconPapers)
Date: 2019
New Economics Papers: this item is included in nep-rmg
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling (2019)
Working Paper: The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling (2017)
Working Paper: The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling (2017)
Working Paper: The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling (2017)
Working Paper: The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling (2013)
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