The Collateral Rule: Theory for the Credit Default Swap Market
24 Pages Posted: 25 Aug 2020
Date Written: July 19, 2020
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: Suggested Citation