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Bilateral counterparty risk valuation for credit default swap in a contagion model using Markov chain

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  • Dong, Yinghui
  • Wang, Guojing

Abstract

The computation of the bilateral counterparty valuation adjustment for a credit default swap (CDS) contract is in effect the modeling of the default dependence among the investor, the protection seller, and the reference entity. We present a contagion model, where defaults of three parties are all driven by a common continuous-time Markov chain describing the macroeconomic conditions. We give the explicit formula for the bilateral credit valuation adjustment (CVA) of CDS and examine the effect of the regime switching on the CVA.

Suggested Citation

  • Dong, Yinghui & Wang, Guojing, 2014. "Bilateral counterparty risk valuation for credit default swap in a contagion model using Markov chain," Economic Modelling, Elsevier, vol. 40(C), pages 91-100.
    • Handle: RePEc:eee:ecmode:v:40:y:2014:i:c:p:91-100
    DOI: 10.1016/j.econmod.2014.03.004
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    References listed on IDEAS

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    10. Bao, Qunfang & Chen, Si & Li, Shenghong, 2012. "Unilateral CVA for CDS in a contagion model with stochastic pre-intensity and interest," Economic Modelling, Elsevier, vol. 29(2), pages 471-477.
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    Cited by:

    1. Harb, Etienne & Louhichi, Wael, 2017. "Pricing CDS spreads with Credit Valuation Adjustment using a mixture copula," Research in International Business and Finance, Elsevier, vol. 39(PB), pages 963-975.
    2. Escribano, Ana & Maggi, Mario, 2019. "Intersectoral default contagion: A multivariate Poisson autoregression analysis," Economic Modelling, Elsevier, vol. 82(C), pages 376-400.
    3. Tingqiang Chen & Binqing Xiao & Haifei Liu, 2018. "Credit Risk Contagion in an Evolving Network Model Integrating Spillover Effects and Behavioral Interventions," Complexity, Hindawi, vol. 2018, pages 1-16, March.
    4. Ferrara, Gerardo & Kim, Jun Sung & Koo, Bonsoo & Liu, Zijun, 2021. "Counterparty choice in the UK credit default swap market: An empirical matching approach," Economic Modelling, Elsevier, vol. 94(C), pages 58-74.
    5. Chen, Tingqiang & Wang, Jiepeng & Liu, Haifei & He, Yuanping, 2019. "Contagion model on counterparty credit risk in the CRT market by considering the heterogeneity of counterparties and preferential-random mixing attachment," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 520(C), pages 458-480.
    6. Samaniego-Medina, Reyes & Trujillo-Ponce, Antonio & Parrado-Martínez, Purificación & di Pietro, Filippo, 2016. "Determinants of bank CDS spreads in Europe," Journal of Economics and Business, Elsevier, vol. 86(C), pages 1-15.
    7. Wang, Lei & Li, Shouwei & Chen, Tingqiang, 2019. "Investor behavior, information disclosure strategy and counterparty credit risk contagion," Chaos, Solitons & Fractals, Elsevier, vol. 119(C), pages 37-49.

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    More about this item

    Keywords

    Credit default swap; Counterparty risk; Credit valuation adjustment; Contagion model; Markov chain;
    All these keywords.

    JEL classification:

    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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