An Economic Examination of Collateralization in Different Financial Markets

descriptionPublicationkeyboard_double_arrow_right Article , Preprint , Research , Other literature type , Report 01 Jan 2013 Germany Publisher:Center for Open ScienceJournal:SSRN Electronic Journal (eissn: 1556-5068,

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Authors: Xiao, Tim;

An Economic Examination of Collateralization in Different Financial Markets

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Abstract

This paper attempts to assess the economic significance and implications of collateralization in different financial markets, which is essentially a matter of theoretical justification and empirical verification. We present a comprehensive theoretical framework that allows for collateralization adhering to bankruptcy laws. As such, the model can back out differences in asset prices due to collateralized counterparty risk. This framework is very useful for pricing outstanding defaultable financial contracts. By using a unique data set, we are able to achieve a clean decomposition of prices into their credit risk factors. We find empirical evidence that counterparty risk is not overly important in credit-related spreads. Only the joint effects of collateralization and credit risk can sufficiently explain unsecured credit costs. This finding suggests that failure to properly account for collateralization may result in significant mispricing of financial contracts. We also analyze the difference between cleared and OTC markets.

Country

Germany

Related Organizations

Ludwig-Maximilians-Universität München
Germany

Keywords

Economics, OTC/cleared/listed financial markets, E44 - Financial Markets and the Macroeconomy, Liquidation, bepress|Business, G12, plumbing of the financial system, G18, Bond Interest Rates, Goodwill, ddc:330, G33 - Bankruptcy, SocArXiv|Social and Behavioral Sciences|Economics, asset pricing, bepress|Social and Behavioral Sciences|Economics|Finance, G28 - Government Policy and Regulation, G32 - Financing Policy, Arabixiv|Business|Finance and Financial Management, G21, unilateral/bilateral collateralization, partial/full/over collateralization, asset pricing, plumbing of the financial system, swap premium spread, OTC/cleared/listed financial markets., Capital and Ownership Structure, G28, bepress|Social and Behavioral Sciences|Economics, G24, G18 - Government Policy and Regulation, Venture Capital, finance, Trading Volume, Financial Risk and Risk Management, G32, G33, Ratings and Ratings Agencies, G12 - Asset Pricing, unilateral/bilateral collateralization, G24 - Investment Banking, Brokerage, SocArXiv|Social and Behavioral Sciences|Economics|Finance, bepress|Business|Finance and Financial Management, bepress|Social and Behavioral Sciences, swap premium spread, E44, Value of Firms, SocArXiv|Social and Behavioral Sciences, Arabixiv|Business, jel: jel:G24, jel: jel:G28, jel: jel:G12, jel: jel:G18, jel: jel:E44, jel: jel:G32, jel: jel:G33

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