Title: An equilibrium pricing for OTC derivatives with non-cash collateralisation

Authors: Kazuhiro Takino

Addresses: Graduate School of Management, Nagoya University of Commerce and Business, 1-3-1 Nishiki Naka-ku, Nagoya 460-0003, Japan

Abstract: In this study, we propose an equilibrium pricing rule for contingent claims traded in over-the-counter (OTC) markets with non-cash collateralisation. Owing to counterparty risks in OTC markets, collateral is required to create a derivative contract. In 2017, Osaka Exchange decided to expand the type of collateral asset, while cash has always been used as a collateral. In this study, we consider a market model in which the required collateral is not cash, and is instead assets with a senior credit class, such as a US Government bond. We further assume that market participants source collateral from the repurchase market (SC repo), where investors can borrow assets. Therefore, we provide an equilibrium pricing model that includes the repo market under counterparty risk. Our pricing rule also determines an equilibrium volume for the derivative contract. This enables us to examine the effects of the repo market on the price and volume for OTC derivative transactions.

Keywords: OTC derivative pricing; counterparty risk; collateral; pricing kernel; repo market.

DOI: 10.1504/IJFMD.2018.097492

International Journal of Financial Markets and Derivatives, 2018 Vol.6 No.4, pp.335 - 364

Received: 17 Jan 2018
Accepted: 28 Oct 2018
Published online: 24 Jan 2019 *

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