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Counterparty Risk and the Impact of Collateralization in CDS Contracts

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  • Tomasz R. Bielecki
  • Igor Cialenco
  • Ismail Iyigunler
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    Abstract

    We analyze the counterparty risk embedded in CDS contracts, in presence of a bilateral margin agreement. First, we investigate the pricing of collateralized counterparty risk and we derive the bilateral Credit Valuation Adjustment (CVA), unilateral Credit Valuation Adjustment (UCVA) and Debt Valuation Adjustment (DVA). We propose a model for the collateral by incorporating all related factors such as the thresholds, haircuts and margin period of risk. We derive the dynamics of the bilateral CVA in a general form with related jump martingales. We also introduce the Spread Value Adjustment (SVA) indicating the counterparty risk adjusted spread. Counterparty risky and the counterparty risk-free spread dynamics are derived and the dynamics of the SVA is found as a consequence. We finally employ a Markovian copula model for default intensities and illustrate our findings with numerical results.

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    File URL: http://arxiv.org/pdf/1104.2625
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1104.2625.

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    Date of creation: Apr 2011
    Date of revision: Aug 2011
    Handle: RePEc:arx:papers:1104.2625

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    Web page: http://arxiv.org/

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