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Credit Valuation Adjustment Modelling During a Global Low Interest Rate Environment

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  • Petr Macek

    (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nábreží 6, 111 01 Prague 1, Czech Republic)

  • Petr Teply

    () (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nábreží 6, 111 01 Prague 1, Czech Republic)

Abstract

The 2008/2009 global crisis highlighted the vulnerabilities and inter-dependencies in the financial system including the global over-the-counter (OTC) derivatives markets, where significant counterparty credit risk prevails. In this paper, we deal with risk under Basel III banking regulation and provide credit valuation adjustment (CVA) modelling, which is a measure of the market value of counterparty credit risk. We use simulated data to develop a stress test model to determine the impact of counterparty credit risk on bank capital regulatory requirements. We developed six scenarios of different interest rate levels and from these scenarios we computed the exposure levels and CVA. Consequently, based on CVA modelling, we estimate the impact of an interest rate hike on portfolios of the top 3 Czech banks (Èeská spoøitelna, ÈSOB and Komerèní banka) and top 3 US banks (Bank of America, Citibank and JP Morgan). We conclude that i) the analyzed Czech banks report sufficient capital buffers to withstand increase of interest rates in any scenario; ii) the observed US banks with high exposure to derivatives would face significant capital shortfalls if the interest rates increase rapidly.

Suggested Citation

  • Petr Macek & Petr Teply, 2015. "Credit Valuation Adjustment Modelling During a Global Low Interest Rate Environment," Working Papers IES 2015/01, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Jan 2015.
  • Handle: RePEc:fau:wpaper:wp2015_01
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    File URL: http://ies.fsv.cuni.cz/sci/publication/show/id/5239/lang/cs
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    Keywords

    bank capital; Basel III; counterparty credit risk; credit valuation adjustment; market risk;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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