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Computing Credit Valuation Adjustment For Bermudan Options With Wrong Way Risk

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  • QIAN FENG

    (Scientific Computing Group, Centrum Wiskunde & Informatica, Science Park 123, 1098 XG, Amsterdam, Netherlands)

  • CORNELIS W. OOSTERLEE

    (Scientific Computing Group, Centrum Wiskunde & Informatica, Science Park 123, 1098 XG, Amsterdam, Netherlands†Applied Mathematics (DIAM), Technische Universiteit Delft, Mekelweg 4, 2628 CD, Delft, Netherlands)

Abstract

We study the impact of wrong way risk (WWR) on credit valuation adjustment (CVA) for Bermudan options. WWR is modeled by a dependency between the underlying asset and the intensity of the counterparty’s default. Two WWR models are proposed, based on a deterministic function and a CIR-jump (CIRJ) model, respectively. We present a nonnested Monte Carlo approach for computing CVA–VaR and CVA–expected shortfall (ES) for Bermudan options. By varying correlation coefficients, we study the impact of credit quality and WWR on the optimal exercise boundaries and CVA values of Bermudan products. Stress testing is performed.

Suggested Citation

  • Qian Feng & Cornelis W. Oosterlee, 2017. "Computing Credit Valuation Adjustment For Bermudan Options With Wrong Way Risk," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 20(08), pages 1-31, December.
    • Handle: RePEc:wsi:ijtafx:v:20:y:2017:i:08:n:s021902491750056x
    DOI: 10.1142/S021902491750056X
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    References listed on IDEAS

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    1. Anastasia Borovykh & Cornelis W. Oosterlee & Andrea Pascucci, 2016. "Pricing Bermudan options under local L\'evy models with default," Papers 1604.08735, arXiv.org.
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    Cited by:

    1. T. van der Zwaard & L. A. Grzelak & C. W. Oosterlee, 2022. "Efficient Wrong-Way Risk Modelling for Funding Valuation Adjustments," Papers 2209.12222, arXiv.org, revised Mar 2023.

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