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      The Impact of Collateralization on Derivative Valuation

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            Abstract

            This paper presents a model for pricing derivatives under collateral posting. Empirically, we find that counterparty risk and collateralization together have high explanatory power on premium spreads. The finding leads to practical implications, such as collateralization modeling allows forecasting credit spread. We also find that credit risk is negatively correlated with collateralization as an increase in collateralization causes a decrease in credit risk. The empirical tests corroborate our theoretical conclusions that collateralization can reduce CVA charges and mitigate counterparty risk.

            Content

            Author and article information

            Journal
            ScienceOpen Preprints
            ScienceOpen
            21 August 2022
            Affiliations
            [1 ] BMO
            Author notes
            Article
            10.14293/S2199-1006.1.SOR-.PPUAZLL.v1
            0630d696-d195-4ec1-86c7-dc2c9d4c5503

            This work has been published open access under Creative Commons Attribution License CC BY 4.0 , which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. Conditions, terms of use and publishing policy can be found at www.scienceopen.com .


            All data generated or analysed during this study are included in this published article (and its supplementary information files).
            Financial economics,Quantitative finance
            collateral posting, asset pricing, derivative valuation, swap premium spread, CVA, credit risk, value at risk.

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