9 papers · 1 filter
Derivatives Discounting Explained
Wujiang Lou
Derivative pricing is about cash flow discounting at the riskfree rate. This teaching has lost its meaning post the financial crisis, due to the addition of extra value adjustments…
The Fair Basis: Funding and capital in the reduced form framework
Wujiang Lou
A negative basis trade enters a long bond position and buys protection on the issuer of the bond through credit default swap (CDS), aiming at arbitrage profit due to the bond-CDS b…
Haircutting Non-cash Collateral
Wujiang Lou
Haircutting non-cash collateral has become a key element of the post-crisis reform of the shadow banking system and OTC derivatives markets. This article develops a parametric hair…
Discounting with Imperfect Collateral
Wujiang Lou
Cash collateral is perfect in that it provides simultaneous counterparty credit risk protection and derivatives funding. Securities are imperfect collateral, because of collateral…
Repo Haircuts and Economic Capital: A Theory of Repo Pricing
Wujiang Lou
A repurchase agreement lets investors borrow cash to buy securities. Financier only lends to securities' market value after a haircut and charges interest. Repo pricing is characte…
Liability-side Pricing of Swaps and Coherent CVA and FVA by Regression/Simulation
Wujiang Lou
An uncollateralized swap hedged back-to-back by a CCP swap is used to introduce FVA. The open IR01 of FVA, however, is a sure sign of risk not being fully hedged, a theoretical no-…
MVA Transfer Pricing
Wujiang Lou
This article prices OTC derivatives with either an exogenously determined initial margin profile or endogenously approximated initial margin. In the former case, margin valuation a…
Coherent CVA and FVA with Liability Side Pricing of Derivatives
Wujiang Lou
This article presents FVA and CVA of a bilateral derivative in a coherent manner, based on recent developments in fair value accounting and ISDA standards. We argue that a derivati…
Extending the Black-Scholes Option Pricing Theory to Account for an Option Market Maker's Funding Costs
Wujiang Lou
An option market maker incurs funding costs when carrying and hedging inventory. To hedge a net long delta inventory, for example, she pays a fee to borrow stock from the securitie…