Abstract
In this paper, we consider the over the counter (OTC) derivatives market model with the counterparty risk and the collateral agreement. We then verify the effect of the collateral agreement on the derivative transaction by using the equilibrium analysis in Microeconomics. We first model the financial market as an incomplete market model which forces us to use the utility-based pricing approach. The option and swap contracts are considered in our study. The former and later correspond the unilateral and bilateral counterparty risk case, respectively. We next derive the demand/supply curves for both derivative contracts by agent's utility maximizations. This leads the equilibrium volumes and prices for the derivative contracts, and enables us to observe the influence of the collateral agreement on these. Our numerical results also verify how the market equilibriums for the derivatives change according to the change of the collateral amount through the demand/supply changes.
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