Collateral convexity complexity

The crisis abolished the risk-free rate, and brought the role of credit support annexes to the fore in derivatives pricing. Paul McCloud develops the general pricing framework that allows the convexity effects to be captured

One of the more persistent after-effects of the market dislocations of recent years has been the significant widening of basis spreads, which has in turn resulted in greater variability in the rates of return on collateral posted in different currencies. Combined with the recognition of the central role that collateral plays in the structure of a trade, this has led to the gradual adoption of a new approach to discounting. But its increased complexity has not been simultaneously matched by a