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arXiv · 1101.3926

Collateral Margining in Arbitrage-Free Counterparty Valuation Adjustment including Re-Hypotecation and Netting

Damiano Brigo·Agostino Capponi·Andrea Pallavicini·Vasileios Papatheodorou
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Abstract

This paper generalizes the framework for arbitrage-free valuation of bilateral counterparty risk to the case where collateral is included, with possible re-hypotecation. We analyze how the payout of claims is modified when collateral margining is included in agreement with current ISDA documentation. We then specialize our analysis to interest-rate swaps as underlying portfolio, and allow for mutual dependences between the default times of the investor and the counterparty and the underlying portfolio risk factors. We use arbitrage-free stochastic dynamical models, including also the effect of interest rate and credit spread volatilities. The impact of re-hypotecation, of collateral margining frequency and of dependencies on the bilateral counterparty risk adjustment is illustrated with a numerical example.

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Damiano Brigo, Agostino Capponi, Andrea Pallavicini, Vasileios Papatheodorou. 2011-01-20. Collateral Margining in Arbitrage-Free Counterparty Valuation Adjustment including Re-Hypotecation and Netting. https://arxiv.org/abs/1101.3926

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