Collateral Volatility

McCloud, Paul

doi:10.2139/ssrn.2260480

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Collateral Volatility

28 Pages Posted: 4 May 2013 Last revised: 4 Jun 2013

See all articles by Paul McCloud

Paul McCloud

University College London - Department of Mathematics

Date Written: May 13, 2013

Abstract

Collateral discounting recognises the value of funding for derivatives, which has gained prominence in recent years as basis spreads have widened in response to the financial crises. This article considers the impact of collateral volatility on discount factors and Libor and FX forwards, and re-examines the core assumptions of the approach. Convenient expressions are derived for convexity adjustments and collateral options, in a form that easily integrates into curve building and pricing. Analysis of the models with reasonable volatility assumptions suggests that these pricing adjustments are not negligible.

Keywords: CSA, Collateral discounting, Collateral volatility, Convexity, Libor, OIS

JEL Classification: G12, G13

Suggested Citation: Suggested Citation

McCloud, Paul, Collateral Volatility (May 13, 2013). Available at SSRN: https://ssrn.com/abstract=2260480 or http://dx.doi.org/10.2139/ssrn.2260480