Risk-Cost Frontier and Collateral Valuation in Securities Settlement Systems for Extreme Market Events

48 Pages Posted: 31 May 2006

Date Written: February 2006

Abstract

In this paper we examine how the use of extreme value theory yields collateral requirements that are robust to extreme fluctuations in the market price of the asset used as collateral. In particular, we study the risk and cost attributes of market risk measures by constructing a risk-cost frontier for the collateral pledged to cover exposures in a securities settlement system. The frontier can be used as a diagnostic tool to understand the risk-cost trade-off of different methodologies to calculate collateral value (haircuts) and select the most efficient alternative in a variety of settings.

Keywords: Collateral under extreme events, high frequency finance, financial risk management

JEL Classification: G00, G10, C10

Suggested Citation

Garcia, Alejandro and Gencay, Ramazan, Risk-Cost Frontier and Collateral Valuation in Securities Settlement Systems for Extreme Market Events (February 2006). Available at SSRN: https://ssrn.com/abstract=905279 or http://dx.doi.org/10.2139/ssrn.905279

Alejandro Garcia (Contact Author)

Bank of Canada ( email )

234 Wellington St.
Ottawa, Ontario K1A 0G9
Canada

Ramazan Gencay

Simon Fraser University ( email )

Department of Economics
8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

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