Abstract
We argue that the only truly credit-risk-free assets in modern economy are those that are fully collateralized on a continuous basis. We develop an asset pricing theory that uses such non-traditional “ingredients” as building blocks and, in particular, does not rely on the existence of a risk-free money market account. We develop a model of multi-currency collateral under the assumption that collateral can be instantaneously replaced, and look at serious complications arising even for simplest derivatives when more realistic assumptions on collateral posting are considered. We then look broadly at how bank funding in general affects discounting, and extend our theory to uncollateralized and partially collateralized derivatives, linking it to previous work.