An equilibrium model for the OTC derivatives market with a collateral agreement

In this study, we consider an over-the-counter (OTC) derivatives market model with counterparty risk and collateral agreement. We verify the effects of collateral agreement on derivative transactions using an equilibrium analysis. Options and forward markets are considered in this study. Options and forward markets correspond to the unilateral and bilateral counterparty risk cases, respectively. We derive the demand and supply functions for both derivative contracts using agent utility maximizations. These lead to the equilibrium prices and volumes for the contracts and enable us to observe the influence of a collateral agreement. We consider a general commodity derivatives market in the numerical implementation. Our numerical results verify how the market equilibriums for derivatives change when the collateral amount changes through shifts in demand and supply.