The Collateral Rule: Theory for the Credit Default Swap Market

24 Pages Posted: 25 Aug 2020

See all articles by Chuan Du

Chuan Du

Yale University

Agostino Capponi

Columbia University

Stefano Giglio

Yale School of Management; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: July 19, 2020

Abstract

We develop a model of endogenous collateral requirements in the credit default swap (CDS) market. Our model provides an interpretation for the empirical findings of Capponi et al. (2020), according to which extreme tail risk measures have a higher explanatory power for observed collateral requirements than standard value at risk rules. The model predicts that this conservativeness of collateral levels can be explained through disagreement of market participants about the extreme states of the world, in which CDSs pay out and counter-parties default.

Keywords: CDS, Collateral Requirement

JEL Classification: G2, G23

Suggested Citation

Du, Chuan and Capponi, Agostino and Giglio, Stefano, The Collateral Rule: Theory for the Credit Default Swap Market (July 19, 2020). Available at SSRN: https://ssrn.com/abstract=3655871 or http://dx.doi.org/10.2139/ssrn.3655871

Chuan Du (Contact Author)

Yale University ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States

Agostino Capponi

Columbia University ( email )

S. W. Mudd Building
New York, NY 10027
United States

Stefano Giglio

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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