Derivative Pricing with Two Collateral Rates

Model Development, muRisQ Advisory, February 2021.

26 Pages Posted: 18 Feb 2021 Last revised: 11 Apr 2021

See all articles by Marc P. A. Henrard

Marc P. A. Henrard

muRisQ Advisory; OpenGamma; University College London - Department of Mathematics

Date Written: February 14, 2021

Abstract

This note analyses derivative pricing in the context of a collateral rate switch during the life of a financial product or the existence of two overnight rates. In particular we analyse the impact of forward change of collateral, the impact on OISs when the collateral rate is different from the OIS underlying, and the impact of bilateral swaptions collateral rate different from the one implied by the cleared market. In each case, we evidence new convexity adjustment impacts previously not accounted for. The order of magnitude of those impacts is also proposed for realistic values of model parameters; the individual relative impacts are not huge, but when applied on trillions of notional, as it is the case, the monetary impacts can be substantial.

Keywords: OIS discounting, collateral, overnight, transition, convexity adjustment

JEL Classification: G13, G15, G23, K12

Suggested Citation

Henrard, Marc P. A., Derivative Pricing with Two Collateral Rates (February 14, 2021). Model Development, muRisQ Advisory, February 2021., Available at SSRN: https://ssrn.com/abstract=3785526 or http://dx.doi.org/10.2139/ssrn.3785526

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