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A Data Driven Approach to Calculate Optimum Collateral Amount for Vulnerable Option


  • Department of Electronics and Computer Engineering, Computer Science and Engineering, KL University, Vaddeswaram, Guntur District - 522502, Andhra Pradesh, India
  • Jawaharlal Nehru Technological University, Kakinada - 533503, Andhra Pradesh, India


Background/Objectives: The main objective of this paper is to present a method that determines optimum collateral amount at which the risk of the venerable option is same as the exchange traded risk. Methods/Statistical Analysis: Mathematical models have been presented in this paper that is related to binomial tree building, Venerable option pricing. An algorithm has also been presented to calculate minimum collateral amount. Experimental models demonstrate the Convergence of Collateral amount and Sensitivity of Vulnerable Option Price to Model Parameters, and Correctness of the optimum collateral amount. Findings: A methodology has been presented in this paper that can be used to compute maximum collateral amount that must be supported by the writer of the option at which the venerable option becomes as risky as the exchange traded risk. This methodology can also be sued when the option writers chooses a fixed collateral amount when the underlying price is greater than the fixed price. A navel binomial decision has been developed and presented considering no assumption of the underlying distribution. It has been found that the price of an option with credit risk converges to exchange traded option as the collateral amount reaches a certain optimal value. The option writer in this can case can use the excess collateral amount for some other purpose. It has also been found that rules that are related to plain vanilla option need not be followed for calculating venerable option.

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