Arbitrage-Free Valuation Of Bilateral Counterparty Risk For Interest-Rate Products: Impact Of Volatilities And Correlations
AbstractThe purpose of this paper is introducing rigorous methods and formulas for bilateral counterparty risk credit valuation adjustment (CVA) on interest-rate portfolios. In doing so, we summarize the general arbitrage-free valuation framework for counterparty risk adjustments in presence of bilateral default risk, including the default of the investor. We illustrate the symmetry in the valuation and show that the adjustment involves a long position in a put option plus a short position in a call option, both with zero strike and written on the residual net present value of the contract at the relevant default times. We allow for correlation between the default times of the investor and counterparty, and for correlation of each with the underlying risk factor, namely interest rates. We also analyze the often neglected impact of credit spread volatility. We include close-out netting rules in our examples, although other agreements, such as periodic margining or collateral posting, are left for future work.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.
Volume (Year): 14 (2011)
Issue (Month): 06 ()
Contact details of provider:
Web page: http://www.worldscinet.com/ijtaf/ijtaf.shtml
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Andrea Pallavicini & Daniele Perini & Damiano Brigo, 2012. "Funding, Collateral and Hedging: uncovering the mechanics and the subtleties of funding valuation adjustments," Papers 1210.3811, arXiv.org, revised Dec 2012.
- Claudio Albanese & Damiano Brigo & Frank Oertel, 2013.
"Restructuring Counterparty Credit Risk,"
International Journal of Theoretical and Applied Finance (IJTAF),
World Scientific Publishing Co. Pte. Ltd., vol. 16(02), pages 1350010-1-1.
- Claudio Albanese & Damiano Brigo & Frank Oertel, 2011. "Restructuring Counterparty Credit Risk," Papers 1112.1607, arXiv.org, revised May 2012.
- Albanese, Claudio & Brigo, Damiano & Oertel, Frank, 2013. "Restructuring counterparty credit risk," Discussion Papers 14/2013, Deutsche Bundesbank, Research Centre.
- Damiano Brigo & Andrea Pallavicini, 2013. "CCPs, Central Clearing, CSA, Credit Collateral and Funding Costs Valuation FAQ: Re-hypothecation, CVA, Closeout, Netting, WWR, Gap-Risk, Initial and Variation Margins, Multiple Discount Curves, FVA?," Papers 1312.0128, arXiv.org, revised Dec 2013.
- Damiano Brigo, 2011. "Counterparty Risk FAQ: Credit VaR, PFE, CVA, DVA, Closeout, Netting, Collateral, Re-hypothecation, WWR, Basel, Funding, CCDS and Margin Lending," Papers 1111.1331, arXiv.org, revised Jun 2012.
- Andrea Pallavicini & Daniele Perini & Damiano Brigo, 2011. "Funding Valuation Adjustment: a consistent framework including CVA, DVA, collateral,netting rules and re-hypothecation," Papers 1112.1521, arXiv.org, revised Dec 2011.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Tai Tone Lim).
If references are entirely missing, you can add them using this form.