Cheapest-to-deliver collateral: a common factor approach

DOI10.1080/14697688.2021.1990375zbMATH Open1496.91092arXiv2103.06107OpenAlexW4206640659MaRDI QIDQ5079362FDOQ5079362

Authors: Felix Wolf, Lech A. Grzelak, Griselda Deelstra 

Publication date: 27 May 2022

Published in: Quantitative Finance (Search for Journal in Brave)

Abstract: The collateral choice option gives the collateral posting party the opportunity to switch between different collateral currencies which is well-known to impact the asset price. Quantification of the option's value is of practical importance but remains challenging under the assumption of stochastic rates, as it is determined by an intractable distribution which requires involved approximations. Indeed, many practitioners still rely on deterministic spreads between the rates for valuation. We develop a scalable and stable stochastic model of the collateral spreads under the assumption of conditional independence. This allows for a common factor approximation which admits analytical results from which further estimators are obtained. We show that in modelling the spreads between collateral rates, a second order model yields accurate results for the value of the collateral choice option. The model remains precise for a wide range of model parameters and is numerically efficient even for a large number of collateral currencies.

Full work available at URL: https://arxiv.org/abs/2103.06107

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zbMATH Keywords

factor modelconditional independenceCSAcollateral choice optioncurrency spreads

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20)

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Cited In (1)

• SENSITIVITIES AND HEDGING OF THE COLLATERAL CHOICE OPTION

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