Pricing and Mitigation of Counterparty Credit Exposures, Agostino Capponi. Purdue University – School of Industrial Engineering. January 31, 2013. Handbook of Systemic Risk, edited by J.-P. Fouque and J.Langsam. Cambridge University Press, 2012
“We analyze the market price of counterparty risk and develop an arbitrage-free pricing valuation framework, inclusive of collateral mitigation. We show that the adjustment is given by the sum of option payoff terms, depending on the netted exposure, i.e. the difference between the on-default exposure and the pre-default collateral account. We specialize our analysis to Interest Rates Swaps (IRS) and Credit Default Swaps (CDS) as underlying portfolio, and perform a numerical study to illustrate the impact of default correlation, collateral margining frequency, and collateral re-hypothecation on the resulting adjustment. We also discuss problems of current research interest in the counterparty risk community.”
