Cooking with collateral

Cooking with collateral

An economy without a risk-free rate has been considered in the past (see Black, 1972) but traditional derivatives pricing theory (see, for example, Duffie, 2001) assumed the existence of such a rate as a matter of course. Until the crisis, this assumption worked well, but now even government bonds cannot be considered credit risk-free. Hence, using a risk-free money-market account or a zero-coupon bond as a foundation for asset pricing theory needs revisiting. While some of the standard construc