Collateral Agreements Research Articles

A New Model for Pricing Collateralized Financial Derivatives

This paper presents a new model for pricing financial derivatives subject to collateralization. It allows for collateral arrangements adhering to bankruptcy laws. As such, the model can back out the market price of a collateralized contract. This framework is very useful for valuing outstanding derivatives. Using a unique dataset, we find empirical evidence that credit risk alone is not overly important in determining credit-related spreads. Only accounting for both collateral posting and credit risk can sufficiently explain unsecured credit costs. This finding suggests that failure to properly account for collateralization may result in significant mispricing of derivatives. We also empirically gauge the impact of collateral agreements on risk measurements. Our findings indicate that there are important interactions between market and credit risk.

Counterparty Credit Risk in OTC Derivatives under Basel III

Recent financial crises were the root of many changes in regulatory implementations in the banking sector. Basel previously covered the default capital charge for counterparty exposures however, the crisis showed that more than two third of the losses related to this risk emerged from the exposure to the movement of the counterparty’s credit quality and not its actual default therefore, Basel III divided the required counterparty risk capital into two categories: The traditional default capital charge and an additional counter-party credit valuation adjustment (CVA) capital charge. In this article, we explain the new methodologies to compute these capital charges on the OTC market: The standardized approach for default capital charge (SA-CCR) and the basic approach for CVA (BA-CVA). Based on historical calibration and future estimations, we built internal models in order to compare them with the amended standardized approach. Up till June 2015, interest rate and FX derivatives constituted more than 90% of the traded total OTC notional amount; we constructed our application on such portfolios containing and computed their total counterparty capital charge. The analysis reflected different impacts of the netting and collateral agreements on the regulatory capital depending on the instruments’ typologies. Moreover, results showed an important increase in the capital charge due to the CVA addition doubling it in some cases.

Accounting for Derivatives with Initial Margin Under IFRS 13

Initial margin is required by central counterparties (CCPs) and under regulatory Bilateral Initial Margin (BCBS-317). This initial margin is contractually defined in Clearing Arrangements (CA) or Collateral Support Deeds (CSD) respectively. We investigate whether the cost of this initial margin over the life of the affected trades (known as Margin Valuation Adjustment, MVA) should be accounted for in Accounting Fair Value under IFRS 13. We find strong indications that MVA should be reflected in Fair Value given that to exit the affected trades any financial institution taking them over would face the same costs from the trades and additional required contracts (CA or CSD) that the first financial institution already faced. In addition the CA/CSD that give rise to MVA are contractually connected to the related trades and contribute to the overall project costs of the trades. These CA/CSD project costs are analogous to costs from cashflows due to Collateral Support Agreements (CSAs) which have a similar contractual relation to trades and CSAs are routinely included in trade pricing. Whether MVA is reported separately or as part of desk activity depends on the applicable unit of account given the internal setup of the financial institution and specific trading patterns following IFRS 9 and IFRS 13.

An equilibrium model for the OTC derivatives market with a collateral agreement

In this study, we consider an over-the-counter (OTC) derivatives market model with counterparty risk and collateral agreement. We verify the effects of collateral agreement on derivative transactions using an equilibrium analysis. Options and forward markets are considered in this study. Options and forward markets correspond to the unilateral and bilateral counterparty risk cases, respectively. We derive the demand and supply functions for both derivative contracts using agent utility maximizations. These lead to the equilibrium prices and volumes for the contracts and enable us to observe the influence of a collateral agreement. We consider a general commodity derivatives market in the numerical implementation. Our numerical results verify how the market equilibriums for derivatives change when the collateral amount changes through shifts in demand and supply.

A proposed quantitative credit-rating methodology for South African provincial departments

The development of subnational credit-rating methodologies affords benefits for subnationals, the sovereign and its citizens. Trusted credit ratings facilitate access to financial markets and above-average ratings allow for the negotiation of better collateral and guarantee agreements, as well as for funding of, for example, infrastructure projects at superior (lower) interest rates. This paper develops the quantitative section of a credit-rating methodology for South African subnationals. The unique characteristics of South African data, their assembly, and the selection of dependent and independent variables for the linear-regression model chosen, are discussed. The methodology is then applied to the provincial Department of Health using linear regression modelling.

An Equilibrium Pricing for OTC Derivatives with Collateralization. Application of Economic Premium Principle

In this article, we propose an equilibrium pricing rule for the contingent claims by applying the economic premium principle initiated by Buhlmann (1980). The derivative markets in our model are over-the-counter (OTC) markets and have counterparty risks. We reconstruct the economic premium principle to explicitly handle the concrete form of the payoff function and the claim volume, and then we provide the equilibrium pricing rule for the OTC derivatives with the counterparty risks and the collateral agreements. We also demonstrate whether our pricing approach is consistent with an another equilibrium pricing rule in the point of the sensitivity of derivative prices.

A New Model for Pricing Collateralized Financial Derivatives

This paper presents a new model for valuing collateralized derivatives. It allows for collateral arrangement adhering to bankruptcy laws. As such, the model can back out the market price of a collateralized contract. This framework is very useful for valuing outstanding derivatives. Using a unique dataset, we find empirical evidence that credit risk alone is not overly important in determining credit-related spreads. Only accounting for both collateral posting and credit risk can sufficiently explain unsecured credit costs. This finding suggests that failure to properly account for collateralization may result in significant mispricing of derivatives. We also empirically gauge the impact of collateral agreements on risk measurements. Our findings suggest that there are important interactions between market and credit risk. We show that market and credit risk are positively correlated, whereas the degree of collateralization is negatively correlated with them.

An Equilibrium Model for the OTC Derivatives Market with a Collateral Agreement

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.

Comparative analysis of informal borrowing behaviour between male and female-headed farm households in the rural communities of Abia state, Nigeria.

The study dealt on the comparative analysis of informal borrowing behaviours between male and female-headed farm households in the rural communities of Abia State, Nigeria. The study was sought to identify the socio-economic characteristics of rural male and female – headed farm households in the study area, and to determine the socio-economic factors that influence borrowing behaviour of rural male and female-headed farm households in Abia State. Multi - stage random sampling technique was adopted in the selection of 216 farm households comprising of 108 male and 108 female headed farm households. Tools of analyses were descriptive statistics of mean and percentages and probit model, The result of the Probit model on the variables influencing borrowing behaviour of male-headed households indicated that the coefficients of household size, farm size, purpose of borrowing, loan duration, interest rate and collateral agreement were the significant variables at varied risk levels, with a Pseudo R2 of 0.814. The significant variables that influenced borrowing behaviour of female-headed households using Probit model were households size, loan size, farm size and borrowing purpose with a Pseudo R2 value of 0.744. The need to drastically reduce the interest rate charged to farm households on borrowed fund, relaxing the issue of collateral was recommended for this study because of its dampening effect on the desire to borrow by the rural households.Keywords: Borrowing behaviour, informal credit, probit model, male and female headed

The possible legal development of the intergation rule in the South African law of contract by means of the doctrine of rectification

Article in AfrikaansAs far back as the early twentieth century the Appellate Division in Cassiem v Standard Bank of SA Ltd, held that:“We are bound by the English rules of evidence and the question has therefore to be decided according to English law, the rule being that parol evidence is not allowed to alter, vary, or contradict a written instrument.”The integration rule has always been an integral part of the South African law of contract where the admissibility of the presentation of extrinsic evidence of previous or collateral agreements was considered. In 1998 an extensive report was brought out by the South African Law Commission wherein certain recommendations were made to the Minister of Justice pertaining to, inter alia, the application of the integration rule in the South African law of contract. The Law Commission was of the opinion that the disadvantages of the integration rule outweighed the advantages of legal certainty and finality and recoomended that the rule be abolished and that more subjective evidence should be allowed to ascertain the true intention of the parties. The recommendations by the Law Commission however apparently died a slow death and there has been no attempt since to abolish or modify the rule in the South African legal system.In 'n previous article the view was held that the integration rule is based on a legal rule or legal fiction and that it can therefore be validly abolished or modified by legislation. Legislation is however a drastic step which should only serve as a last resort and other alternatives should first be considered. This article considers one such a possible alternative, namely the remedy of rectification. The focus will be in particular on a brief discussion of the application of the integration rule in the South African law of contract, the field of application and scope of rectification, the relation between rectification and the integration rule, and, lastly, if rectification can be utilised to avoid the strict application of the integration rule and consequently serve as an instrument for the (indirect) abolition or modification of the rule in the South-African law of contract. The conclusion is that the remedy of rectification would in all probability not in all instances be able to avoid the strict application of the integration rule and that legislation seems to be the only workable alternative to abolish or modify the integration rule in the South African law of contract.Keywords: abolish; common intention; extrinsic evidence; integration rule; law of contract; legislation; mistake; modify; rectification; written contract.

Collateral and credit issues in derivatives pricing

Regulatory changes are increasing the importance of collateral agreements and credit issues in over-the-counter derivatives transactions. This paper considers the nature of derivatives collateral agreements and examines the impact of collateral agreements, two-sided credit risk, funding costs, liquidity, and bid-offer spreads on the valuation of derivatives portfolios.

Fertilizer adoption, credit access, and safety nets in rural Ethiopia

Purpose – The purpose of this paper is to investigate the impact of access to credit and safety nets on fertilizer adoption in rural Ethiopia. Design/methodology/approach – A panel data set collected in 2005 and 2007 on 278 households and over 5,700 plots from the Southern Highlands of Ethiopia is examined. The authors developed a theoretical model relating input use and credit contract under third-party credit collateral agreement. The estimation is based on instrumental variables regressions to account for the endogeneity of credit access, and safety nets in fertilizer demand equation. Findings – Despite increasing trends in fertilizer and improved varieties adoption since mid-2003, only 22 percent of the plots in the sample is actually received fertilizer. Households with more assets measured by livestock wealth are more likely to adopt fertilizer but less likely to participate in the local credit market as they have better savings that could be used to buy fertilizer/improved seeds without credit contract. This suggests poorer farmers heavily depend on credit than wealthier. Participation in safety nets programs did not contribute for increased use of fertilizer suggesting that the program either competes with agricultural labor or the low wage income was not enough to pay for farm inputs. Practical implications – The findings show that with a heavier reliance on credit by poorer farmers it appears that much might be gained by targeting policies toward increasing credit access to this group. Originality/value – Studies that utilize repeated plot- and household-level observations are limited. To the knowledge, this is the first study showing the relationship between credit accesses, public work program and fertilizer adoption over time in rural Ethiopia.

ASAS PUBLISITAS PADA HAK JAMINAN ATAS RESI GUDANG

The principle of publicity is closely related to property rights. Each of Guarantee Agency property rights in a way that is different. Loading Right Collateral Agreements on the warehouse receipt no later than a day after the date of imposition oft he rights agreement collateral to a second party warehouse receipt, which is the guarantee of the assignees hall notify the Registration Center Warehouse Receipt System in order to be recorded in the Register of Rights guarantee Imposition Top Warehouse Receipt. Then the Registration Center will issue a notice of the imposition of Rights Confirmation Proof Guarantee. The meaning of “notice” to sign if the birth registration of property rights on the Rights of the collateral for the warehouse receipt. This is done to avoid double guarantee and monitor the distribution of the warehouse receipt and provide legal certainty about th eparty entitled tothe goods in the event of injury promise.Key words: publicity,collateral,warehouse receipts.

Rehypothecation dilemma: Impact of collateral rehypothecation on derivative prices under bilateral counterparty credit risk

Rehypothecation is the practice where a derivatives dealer reuses collateral posted from its end user in over-the-counter (OTC) derivatives markets. Although rehypothecation benefits the end user through cost reduction of derivative trades, it also creates additional counterparty credit risk since the end user may not receive the collateral back when the dealer suddenly defaults. To evaluate the benefits and risks of rehypothecation, we propose a derivative pricing framework with bilateral counterparty credit risk that determines the amount of rehypothecable collateral. We also model the realistic features of derivative trades: two different types of collateral, the time delay of collateral posting and the rating-dependent collateral agreement. We apply our pricing framework to cross currency swaps and investigate the impact of rehypothecation on the swap spreads.

Hedging the 'One-Way CSA' Counterparty Risk in a CDO

We show how to restructure the counterparty risk faced by the originator of a securitization or covered bond arising from an interest rate hedging swap assisted by a one-way collateral agreement. This risk emerges when the swap is negotiated between the special purpose vehicle and a third party that covers itself through a back-to-back swap with the originator. We show that the counterparty risk of the originator may be removed by adding a chain of back-to-back credit derivatives between the three parties (originator, counterparty and vehicle).

Optimal Architecture for Modern Analytics Platforms

Financial derivatives are now in ubiquitous use around the globe to hedge exposure and as vehicles for speculation. Four years on from the worst financial crisis in almost a century, the world is still recovering. Yet the derivatives markets continue to grow, and have more than recovered from the slight pull-back after the crisis of 2008. According to the Bank of International Settlements, as of June 2011 the total global notional of outstanding OTC derivatives was US$707 trillion, having surpassed the previous high point of around US$670 trillion in June 2008. Prior to that, the market had been doubling every three years or so. The fundamental need to transfer risk in exchange for long-term reward will persist, while financial markets throughout the world continue to develop in size and maturity.Increased regulatory scrutiny and a heightened sensitivity to counterparty credit risk since the crisis have forced fundamental changes in how even the most vanilla derivatives are valued. More widespread use of collateral has imposed new levels of complexity on the most basic and preliminary task for any financial calculation: the construction of a discount curve. The option to choose collateral currency, nominally present in some collateral agreements, has even prompted analysis of whether a so-collateralized vanilla swap in fact has non-negligible exposure to the volatility of certain spreads. Accounting for the effect of counterparty exposure (calculating a Credit Value Adjustment /CVA) on the value of a portfolio of vanilla derivatives requires a level of flexibility and sophistication matching that previously applied to highly complex exotics. Even without CVA, certain types of life-insurance policies available to retail investors cannot be valued appropriately without sophisticated modeling and computational techniques traditionally only needed for exotic trades.The modeling of financial derivatives is performed by quantitative analysts. Although their critical contribution is in making well-judged modeling decisions that provide adequate account for the factors that influence the value of a trade or portfolio, a practical reality of a quant's role is that calculations must be implemented in software systems. A typical quant's expertise in computing is heavily skewed toward obtaining accurate and robust numerical results; getting the numbers right. A consequence of this emphasis on the details is that the big picture is often missed. Code often evolves rather than being designed. New variants of existing pricing calculations are implemented without direct reuse of the shared parts. New trades or models prompt bespoke development which at times amount to nothing more than a highly paid form of repetitive manual labor.The missing ingredient here is architecture; the overall design of a system informed by a deep understanding of the fundamental concepts which underpin the domain and the nature of the information that flows and interacts when problems are solved in the domain. It is architecture that facilitates true flexibility, modularity and sub-component reuse, and without a clear treatment of the concepts relevant to the problem domain, the goal of constructing an effective architecture remains elusive. A major cause of this deficiency is that individuals with the necessary rich architectural vision are rare and expensive, particularly outside the realm of top-tier sell-side institutions. In this paper, we tackle precisely this issue - the fundamental concepts and design ideas that must underpin the architecture of a modern analytics platform.

Rehypothecation Dilemma: Impact of Collateral Rehypothecation on Derivative Prices Under Bilateral Counterparty Credit Risk

Rehypothecation is the practice where a derivatives dealer reuses collateral posted from its end user in over-the-counter (OTC) derivatives markets. Although rehypothecation benefits the end user through cost reduction of derivative trades, it also creates additional counterparty credit risk since the end user may not receive the collateral back when the dealer suddenly defaults. To evaluate the benefits and risks of rehypothecation, we propose a derivative pricing framework with bilateral counterparty credit risk that determines the amount of rehypothecable collateral. We also model the realistic features of derivative trades: two different types of collateral, the time delay of collateral posting and the rating-dependent collateral agreement. We apply our pricing framework to cross currency swaps and investigate the impact of rehypothecation on the swap spreads.

Everything You Always Wanted to Know about Multiple Interest Rate Curve Bootstrapping but Were Afraid to Ask

After the credit and liquidity crisis started in summer 2007 the market has recognized that multiple yield curves are required for estimation of both discount and FRA rates with dfferent tenors (e.g. Overnight, Libor 3 months, etc.), consistently with the large basis spreads and the wide diffusion of bilateral collateral agreements and central counterparties for derivatives transactions observed on the market. This paper recovers and extends our previous work to the modern multiple-curve bootstrapping of both discounting and FRA yield curves, consistently with the funding of market instruments. The theoretical pricing framework is introduced and modern pricing formulas for plain vanilla interest rate derivatives, such as Deposits, Forward Rate Agreements (FRA), Futures, Swaps, OIS, and Basis Swaps, are derived from scratch. The concrete EUR market case is worked out, and many details are discussed regarding the selection of market instruments, synthetic market quotes, smooth interpolation, effect of OIS discounting, possible negative rates, turn of year effect, local vs non local delta sensitivities, performance and yield curve sanity checks. The implementation of the proposed algorithms is available open source within the QuantLib framework.

Collateral and Credit Issues in Derivatives Pricing

Regulatory changes are increasing the importance of collateral agreements and credit issues in over-the-counter derivatives transactions. This paper considers the nature of derivatives collateral agreements and examines the impact of collateral agreements, two-sided credit risk, funding costs, liquidity, and bid-offer spreads on the valuation of derivatives portfolios.

Markets Evolution after the Credit Crunch

We review the main changes in the interbank market after the financial crisis started in August 2007. In particular, we focus on the fixed income market and we analyse the most relevant empirical evidences regarding the divergence of the existing basis between interbank rates with different tenor, such as Libor and OIS. We also discuss a qualitative explanation of these effects based on the consideration of credit and liquidity variables. Then, we focus our attention on the diffusion of collateral agreements among OTC derivatives market counterparties, and on the consequent change of paradigm for pricing derivatives. We illustrate the main qualitative features of the new market practice, called CSA discounting, and we point out the most relevant issues for market players associated to its adoption.