An Equilibrium Pricing for OTC Derivatives with Non-Cash Collateralization

Year：2017 NO： Author：Kazuhiro Takino

In this study, we propose an equilibrium pricing rule for contingent claims traded in over-the-counter (OTC) markets with non-cash collateralization. Owing to counterparty risks in OTC markets, collateral is required to create a derivative contract. The class of assets used as collateral has recently expanded, while cash has always been used as a collateral. Here, we suppose that 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. Using our pricing rule, we examine the effects of the repo market on OTC derivative transactions from a microeconomics point of view.

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