• Credit Derivatives

    Di fferential discounting for collateralized CDS: why, how, and what are the underlying assumptions?

    In the post-crisis derivative pricing literature one often fi nds the statement that the pricing of a collateralized derivative is the same as the pricing of its uncollateralized counterpart, only with adjusted discount factors. We re-derive this statement in the particular case of a CDS by a cashflow-oriented approach, emphasizing the hidden assumptions underlying this derivation. In particular, said pricing technique completely ignores counterparty credit risk and - if more than one currency is involved - necessarily relies on the assumption of funding-dependent discounting. If collateral is posted, the interest rate that has to be paid on the collateral dictates the choice of discounting curve.