Risk-Neutral Valuation Under Differential Funding Costs, Defaults and Collateralization

33 Pages Posted: 7 Mar 2018

See all articles by Damiano Brigo

Damiano Brigo

Imperial College London - Department of Mathematics

Cristin Buescu

King's College London, Department of Mathematics

Marco Francischello

Imperial College London - Department of Mathematics

Andrea Pallavicini

Banca IMI; Imperial College London - Department of Mathematics

Marek Rutkowski

The University of Sydney - School of Mathematics and Statistics

Date Written: February 28, 2018

Abstract

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

Brigo, Damiano and Buescu, Cristin and Francischello, Marco and Pallavicini, Andrea and Rutkowski, Marek, Risk-Neutral Valuation Under Differential Funding Costs, Defaults and Collateralization (February 28, 2018). Available at SSRN: https://ssrn.com/abstract=3131352 or http://dx.doi.org/10.2139/ssrn.3131352

Damiano Brigo

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www.imperial.ac.uk/people/damiano.brigo

Cristin Buescu (Contact Author)

King's College London, Department of Mathematics ( email )

Strand
London, WC2R 2LS
United Kingdom

Marco Francischello

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
Imperial College
LONDON, SW7 2AZ
United Kingdom

Andrea Pallavicini

Banca IMI ( email )

Largo Mattioli 3
Milan, MI 20121
Italy
+39 02 7261 (Phone)

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom

Marek Rutkowski

The University of Sydney - School of Mathematics and Statistics ( email )

Sydney, New South Wales 2006
Australia

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