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Impact of the first to default time on Bilateral CVA


  • Damiano Brigo
  • Cristin Buescu
  • Massimo Morini


We compare two different bilateral counterparty valuation adjustment (BVA) formulas. The first formula is an approximation and is based on subtracting the two unilateral Credit Valuation Adjustment (CVA)'s formulas as seen from the two different parties in the transaction. This formula is only a simplified representation of bilateral risk and ignores that upon the first default closeout proceedings are ignited. As such, it involves double counting. We compare this formula with the fully specified bilateral risk formula, where the first to default time is taken into account. The latter correct formula depends on default dependence between the two parties, whereas the simplified one does not. We also analyze a candidate simplified formula in case the replacement closeout is used upon default, following ISDA's recommendations, and we find the simplified formula to be the same as in the risk free closeout case. We analyze the error that is encountered when using the simplified formula in a couple of simple products: a zero coupon bond, where the exposure is unidirectional, and an equity forward contract where exposure can go both ways. For the latter case we adopt a bivariate exponential distribution due to Gumbel to model the joint default risk of the two parties in the deal. We present a number of realistic cases where the simplified formula differs considerably from the correct one.

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  • Damiano Brigo & Cristin Buescu & Massimo Morini, 2011. "Impact of the first to default time on Bilateral CVA," Papers 1106.3496,
  • Handle: RePEc:arx:papers:1106.3496

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    References listed on IDEAS

    1. Damiano Brigo & Massimo Morini, 2010. "Dangers of Bilateral Counterparty Risk: the fundamental impact of closeout conventions," Papers 1011.3355,
    2. Damiano Brigo & Agostino Capponi & Andrea Pallavicini & Vasileios Papatheodorou, 2011. "Collateral Margining in Arbitrage-Free Counterparty Valuation Adjustment including Re-Hypotecation and Netting," Papers 1101.3926,
    3. Damiano Brigo & Andrea Pallavicini & Vasileios Papatheodorou, 2009. "Bilateral counterparty risk valuation for interest-rate products: impact of volatilities and correlations," Papers 0911.3331,, revised Feb 2010.
    4. Lindskog, Filip & McNeil, Alexander J., 2003. "Common Poisson Shock Models: Applications to Insurance and Credit Risk Modelling," ASTIN Bulletin: The Journal of the International Actuarial Association, Cambridge University Press, vol. 33(02), pages 209-238, November.
    5. Damiano Brigo & Agostino Capponi, 2008. "Bilateral counterparty risk valuation with stochastic dynamical models and application to Credit Default Swaps," Papers 0812.3705,, revised Nov 2009.
    6. Duffie, Darrell & Huang, Ming, 1996. " Swap Rates and Credit Quality," Journal of Finance, American Finance Association, vol. 51(3), pages 921-949, July.
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    Cited by:

    1. Damiano Brigo & Agostino Capponi & Andrea Pallavicini, 2014. "Arbitrage-Free Bilateral Counterparty Risk Valuation Under Collateralization And Application To Credit Default Swaps," Mathematical Finance, Wiley Blackwell, vol. 24(1), pages 125-146, January.
    2. Lorenzo Giada & Claudio Nordio, 2012. "Funded Bilateral Valuation Adjustment," Papers 1211.1564,
    3. Andrea Pallavicini & Daniele Perini & Damiano Brigo, 2012. "Funding, Collateral and Hedging: uncovering the mechanics and the subtleties of funding valuation adjustments," Papers 1210.3811,, revised Dec 2012.
    4. 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,, revised Jun 2012.
    5. Zhou, Richard, 2015. "Exact Methods for Path-Dependent Credit Exposure," MPRA Paper 64647, University Library of Munich, Germany, revised 25 May 3025.
    6. Zhou, Richard, 2015. "Modeling Path Dependent Counterparty Credit Risk," MPRA Paper 61354, University Library of Munich, Germany.
    7. 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,, revised Dec 2011.
    8. Lorenzo Giada & Claudio Nordio, 2012. "Bilateral Credit Valuation Adjustment of an Optional Early Termination Clause," Papers 1205.2013,, revised Jan 2013.

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