CSA Discounting: Impacts on Pricing and Risk of Commodity Derivatives

DOI: 10.4236/jfrm.2014.33011   PDF   HTML     10,001 Downloads   11,543 Views   Citations


The global financial crisis of 2007-2008 caused market practitioners to reassess the way in which financial derivative contracts had been priced during the preceding thirty years. The purpose of this paper is to examine the evolving practice of pricing and hedging commodity derivative contracts according to the terms of the Credit Support Annex (CSA). Using a series of case studies, we price crude oil swaps and Asian options in the pre-crisis, peak-crisis, post-crisis and recent market environments under two different frameworks: LIBOR discounting and CSA discounting (also referred to in a less general form as “OIS discounting”, which incorporates nearly risk-free interest rates). We also compute the widely used first-order and second-order Greek sensitivities. In each market environment, we shift the forward prices and implied volatilities crude oil and re-compute the trades’ valuation and Greek sensitivities at each incremental increase or decrease in price or implied volatility. Under each discounting framework, we quantify the change in trade valuation and Greek sensitivities that results from switching from LIBOR discounting to CSA discounting. The impact on the valuation and Greek sensitivities of a swap and an Asian option as the result of adopting CSA discounting can be significant under certain market conditions. There is likely to be larger impact on directional portfolios containing transactions that hedge either consumption or production (e.g. end users). Ceteris paribus, the impact on portfolio valuation and risk is likely to be limited for market participants (e.g. banks) with hedged portfolios that contain a large number of offsetting positions. Even though we focus our analysis on crude oil derivative contracts, the results easily extend to other asset classes such as natural gas, refined products, agriculture, metals, etc.

Share and Cite:

Abbate, R. (2014) CSA Discounting: Impacts on Pricing and Risk of Commodity Derivatives. Journal of Financial Risk Management, 3, 113-142. doi: 10.4236/jfrm.2014.33011.

Conflicts of Interest

The authors declare no conflicts of interest.


[1] Bank for International Settlements (2011). Liquidity Transfer Pricing: A Guide to Better Practice. Retrieved January 14, 2014, from Bank for International Settlements.
[2] Bloomberg, L. P. (2014). 3-Month U.S. Dollar Overnight Index Swap. 04-Dec-2001 to 27-Jan-2014. Retrieved from Bloomberg Database.
[3] Brigo, D., & Masetti, M. (2005). Risk-Neutral Pricing of Counterparty Risk. In M. Pykhtin (Ed.), Counterparty Credit Risk Modeling: Risk Management, Pricing and Regulation. London: Risk Books.
[4] Cameron, M. (2013). Goldman and the OIS Gold Rush: How Fortunes Were Made from a Discounting Change.
[5] Canabarro, E., Picoult, E., & Wilde, T. (2005). Counterparty Risk, Energy Risk, May Issue.
[6] FASB ASC 820-10-35-25
[7] Gabillion, J. (1991). The Term Structure of Oil Futures Prices. Working Paper, No. M17, Oxford Institute for Energy Studies.
[8] Hull, J., & White, A. (2012). LIBOR vs. OIS: The Derivatives Discounting Dilemma. Journal of Investment Management, 11, 14-27.
[9] International Swaps and Derivatives Association, Inc. (2013, June 21). ISDA Margin Survey 2013.
[10] International Swaps and Derivatives Association, Inc. (2013, October 23). 2013 Best Practices for OTC Derivatives Collateral Process.
[11] Mollencamp, C. (2008). Bankers Cast Doubt on Key Rate Amid Crisis. The Wall Street Journal: http://online.wsj.com/
[12] Pallavicini, A., Perini, D., & Brigo, D. (2011). Funding Valuation Adjustment: A Consistent Framework Including CVA, DVA, Collateral, Netting Rules and Re-Hypothecation.
[13] Securities and Exchange Commission (2011). SEC Response Letter.
[14] Sorenson, E. H., & Bollier, T. F. (1994). Pricing Swap Default Risk. Financial Analysts Journal, 50, 23-33.
[15] Turnbull, S., & Wakeman, L. (1991). A Quick Algorithm for Pricing European Average Options. Journal of Financial and Quantitative Analysis, 26, 377-389.

comments powered by Disqus

Copyright © 2020 by authors and Scientific Research Publishing Inc.

Creative Commons License

This work and the related PDF file are licensed under a Creative Commons Attribution 4.0 International License.