Valuing Zero Floors on Collateral Rates in Derivatives CSAs

Summary

A zero floor in a Credit Support Annex prevents the rate paid on cash collateral from falling below zero, even when the overnight index swap rate is negative. The document explains that the floor’s value is relative to an otherwise comparable agreement without the floor, and that its economic benefit to one counterparty is an equal cost to the other.

The value depends on how the derivatives portfolio behaves when rates are negative. For example, a portfolio that becomes a large receivable to a given counterparty in that environment can make the floor unfavorable to that party. Accurate valuation requires modeling the portfolio’s trades jointly with their correlation to OIS rates; a multi-asset Monte Carlo model is one possible framework. The discussion emphasizes that calibration is difficult and that many banks lack precise valuation technology, so it provides conceptual guidance rather than a practical pricing recipe.

Key ideas

• A zero floor prevents the collateral remuneration rate from becoming negative.
• The floor’s value to one CSA counterparty is an equal and opposite value to the other.
• Portfolio exposure in negative-rate scenarios affects which party benefits.
• Valuation requires modeling correlations between OIS rates and the portfolio’s trades.
• Multi-asset Monte Carlo methods may be used, but calibration remains difficult.

Tags

# How to price 0 floors in csa agreements for negative ois rates?


# How to price 0 floors in csa agreements for negative ois rates?












A CSA (Credit Support Annex) agreement specifies the interest rate to be earned on the collateral provided to back a derivatives transaction. For cash collateral this rate is generally the OIS (overnite index swap rate). A 'zero floor' refers to the provision that the i.r. rate applied may not be negative.

How to determine the value 0 floors in csa agreements in a world where negative ois rates are possible?

## Answer by dm63 (score 2, accepted)

https://quant.stackexchange.com/a/31841

A couple of observations

(A) if the value of the floor, relative to a non floored CSA, is worth an amount X to one of the counterparties to the CSA, then it is worth -X to the other counterparty.

(B) The value of the floor depends on what is in the derivatives portfolio under that CSA. If, from your perspective as Counterparty A, the portfolio becomes a big receivable when ois rates are negative, then X is negative for you.

(C) the exact valuation requires a complex model that can handle the correlation between all trades that are in the portfolio, versus ois rates. If there are multiple asset classes represented in the portfolio, this could be handled by a multiasset Monte Carlo Model. Even then, calibration would not be easy. Most banks haven't developed precise technology for this.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.