Risk-Neutral Valuation Under Differential Funding Costs, Defaults and Collateralization
33 Pages Posted: 7 Mar 2018
Date Written: February 28, 2018
We develop a unified valuation theory that incorporates credit risk (defaults), collateralization and funding costs, by expanding the replication approach to a generality that has not yet been studied previously and reaching valuation when replication is not assumed. This unifying theoretical framework clarifies the relationship between the two valuation approaches: the adjusted cash flows approach pioneered for example by Brigo, Pallavicini and co-authors and the classic replication approach illustrated for example by Bielecki and Rutkowski and co-authors. In particular, results of this work cover most previous papers where the authors studied specific replication models.
Keywords: risk-neutral valuation, replication, funding costs, default, collateral
JEL Classification: G12
Suggested Citation: Suggested Citation