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An Accurate Solution for Credit Valuation Adjustment and Wrong Way Risk

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  • Tim Xiao

    (University of Toronto)

Abstract

This paper presents a Least Square Monte Carlo approach for accurately calculating credit value adjustment (CVA). In contrast to previous studies, the model relies on the probability distribution of a default time/jump rather than the default time itself, as the default time is usually inaccessible. As such, the model can achieve a high order of accuracy with a relatively easy implementation. We find that the valuation of a defaultable derivative is normally determined via backward induction when their payoffs could be positive or negative. Moreover, the model can naturally capture wrong or right way risk. Acknowledge: The data were provided by FinPricing at www.finpricing.com/lib/IrSwap.html Key Words: credit value adjustment (CVA), wrong way risk, right way risk, credit risk modeling, least square Monte Carlo, default time approach (DTA), default probability approach (DPA), collateralization, margin and netting. 1 The views expressed here are of the author alone and not necessarily of his host institution.

Suggested Citation

  • Tim Xiao, 2015. "An Accurate Solution for Credit Valuation Adjustment and Wrong Way Risk," Post-Print hal-01810490, HAL.
  • Handle: RePEc:hal:journl:hal-01810490
    DOI: 10.3905/jfi.2015.25.1.084
    Note: View the original document on HAL open archive server: https://hal.science/hal-01810490v1
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    Cited by:

    1. Xiao, Tim, 2018. "The Valuation of Financial Derivatives Subject to Counterparty Risk and Credit Value Adjustment," FrenXiv ds7zj, Center for Open Science.
    2. Xiao, Tim, 2018. "The Valuation of Credit Default Swap with Counterparty Risk and Collateralization," EconStor Preprints 203447, ZBW - Leibniz Information Centre for Economics.
    3. Lee, David, 2018. "Pricing Financial Derivatives Subject to Counterparty Risk and Credit Value Adjustment," MPRA Paper 85575, University Library of Munich, Germany.
    4. Tim Xiao, 2017. "A New Model for Pricing Collateralized Financial Derivatives," Post-Print hal-01800559, HAL.
    5. 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.

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