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Credit Value Adjustment with Market-implied Recovery

Author

Listed:
  • Pascal François

    (HEC Montreal)

  • Weiyu Jiang

    (McGill University)

Abstract

We present a model for CVA calculation in which the recovery rate is inferred from the term structure of CDS spreads. The negative relation between recovery rates and default probabilities induces a substantial underestimation of the CVA when constant recovery is assumed. That underestimation prevails for both unilateral and bilateral CVA as well as for the CVA capital charge. The underestimation gets more severe as the horizon of the position increases. Our CVA model with market-implied recovery also offers a way to capture correlation effects between the level of exposure and counterparty risk.

Suggested Citation

  • Pascal François & Weiyu Jiang, 2019. "Credit Value Adjustment with Market-implied Recovery," Journal of Financial Services Research, Springer;Western Finance Association, vol. 56(2), pages 145-166, October.
    • Handle: RePEc:kap:jfsres:v:56:y:2019:i:2:d:10.1007_s10693-018-0298-5
    DOI: 10.1007/s10693-018-0298-5
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    References listed on IDEAS

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    Cited by:

    1. Pascal François, 2019. "The Determinants of Market-Implied Recovery Rates," Risks, MDPI, vol. 7(2), pages 1-15, May.
    2. Barbagli, Matteo & François, Pascal & Gauthier, Geneviève & Vrins, Frédéric, 2024. "The role of CDS spreads in explaining bond recovery rates," LIDAM Discussion Papers LFIN 2024002, Université catholique de Louvain, Louvain Finance (LFIN).
    3. Jean‐François Bégin & Mathieu Boudreault & Mathieu Thériault, 2024. "Leveraging prices from credit and equity option markets for portfolio risk management," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 44(1), pages 122-147, January.

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