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Bilateral Counterparty Risk Valuation on a CDS with a Common Shock Model

Author

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  • Yinghui Dong

    (Suzhou University of Science and Technology)

  • Guojing Wang

    (Soochow University)

  • Kam C. Yuen

    (University of Hong Kong)

Abstract

In this paper, we study the counterparty risk on a CDS in a common shock model. We introduce the general arbitrage-free valuation framework for counterparty risk adjustments in presence of bilateral default risk. Especially, we consider the pricing problem of credit default swap with counterparty risk under a common shock model with regime switching. The arrivals of the shock events are modeled by conditionally independent Cox processes whose stochastic intensities depend on the state of the economy described by a Markov chain. We give the explicit formula for the credit valuation adjustment (CVA) and examine the impact of the change of economic state on the CVA.

Suggested Citation

  • Yinghui Dong & Guojing Wang & Kam C. Yuen, 2014. "Bilateral Counterparty Risk Valuation on a CDS with a Common Shock Model," Methodology and Computing in Applied Probability, Springer, vol. 16(3), pages 643-673, September.
    • Handle: RePEc:spr:metcap:v:16:y:2014:i:3:d:10.1007_s11009-013-9323-1
    DOI: 10.1007/s11009-013-9323-1
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    References listed on IDEAS

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    Cited by:

    1. Masahiko Egami & Rusudan Kevkhishvili, 2016. "An Analysis of Simultaneous Company Defaults Using a Shot Noise Process," Discussion papers e-16-001, Graduate School of Economics , Kyoto University.

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