Rethinking Valuation and Pricing Models

2

Taking Collateral into Account

Messaoud Chibane, Yi-Chen Huang and Jayaprakash Selvaraj

Shinsei Bank

Chapter Outline

2.1 Introduction

2.2 Notations and Problem

2.3 Black–Scholes Partial Differential Equation in the Presence of Collateral

2.4 Collateral Discount Curve Bootstrapping

2.5 Pricing and Bootstrapping of the IR Vanilla Swap Term Structure

2.6 European Swaption Pricing Framework

2.7 Collateral Effect and Term-Structure Models

2.8 Conclusion

References

2.1 Introduction

With the start of the credit crunch in summer 2007 and the subsequent upheavals in market conditions, all the basic assumptions used in derivatives pricing, such as infinite liquidity and no counterparty default risk, have been called into question. Practitioners first ...