Price Impacts of Imperfect Collateralization (Revised version of CARF-F-355; Subsequently published in “International Journal of Financial Engineering”)

Abstract

This paper studies impacts of imperfect collateralization on derivatives values. Particularly, we investigate option prices in no collateral posting and time-lagged collateral posting cases with stochastic volatility, interest rate and default intensity models, where a stochastic collateral asset value may depend on the values of the assets different from the underlying contract. We also derive an approximation of the credit value adjustment (CVA)’s density function in pricing forward contract with bilateral counter party risk, which seems useful in evaluation of the CVA’s Value-at-Risk(VaR).