IDEAS home Printed from https://ideas.repec.org/p/pra/mprapa/19684.html

Double Impact on CVA for CDS: Wrong-Way Risk with Stochastic Recovery

Author

Listed:
  • Li, Hui

Abstract

Current CVA modeling framework has ignored the impact of stochastic recovery rate. Due to the possible negative correlation between default and recovery rate, stochastic recovery rate could have a doubling effect on wrong-way risk. In the case of a payer CDS, when counterparty defaults, the CDS value could be higher due to default contagion while the recovery rate may also be lower if the economy is in a downturn. Using our recently proposed model of correlated stochastic recovery in the default time Gaussian Copula framework, we demonstrate this double impact on wrong-way risk in the CVA calculation for a payer CDS. We also present a new form of Gaussian copula that correlates both default time and recovery rate.

Suggested Citation

  • Li, Hui, 2009. "Double Impact on CVA for CDS: Wrong-Way Risk with Stochastic Recovery," MPRA Paper 19684, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:19684
    as

    Download full text from publisher

    File URL: https://mpra.ub.uni-muenchen.de/19684/1/MPRA_paper_19684.pdf
    File Function: original version
    Download Restriction: no
    File URL: https://mpra.ub.uni-muenchen.de/19846/3/MPRA_paper_19846.pdf
    File Function: revised version
    Download Restriction: no
    File URL: https://mpra.ub.uni-muenchen.de/20365/2/MPRA_paper_20365.pdf
    File Function: revised version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Damiano Brigo & Agostino Capponi, 2008. "Bilateral counterparty risk valuation with stochastic dynamical models and application to Credit Default Swaps," Papers 0812.3705, arXiv.org, revised Nov 2009.
    2. Li, Hui, 2009. "Extension of Spot Recovery Model for Gaussian Copula," MPRA Paper 17944, University Library of Munich, Germany.
    3. Christophette Blanchet-Scalliet & Fr'ed'eric Patras, 2008. "Counterparty risk valuation for CDS," Papers 0807.0309, arXiv.org.
    4. Li, Hui, 2009. "On Models of Stochastic Recovery for Base Correlation," MPRA Paper 15750, University Library of Munich, Germany.
    5. Li, Hui, 2008. "CVA calculation for CDS on super senior ABS CDO," MPRA Paper 17945, University Library of Munich, Germany.
    6. Damiano Brigo & Kyriakos Chourdakis, 2009. "Counterparty Risk For Credit Default Swaps: Impact Of Spread Volatility And Default Correlation," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 12(07), pages 1007-1026.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Li, Hui, 2010. "Downturn LGD: A Spot Recovery Approach," MPRA Paper 20010, University Library of Munich, Germany.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Hui Li, 2013. "A Note On The Double Impact On Cva For Cds: Wrong-Way Risk With Stochastic Recovery," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(03), pages 1-14.
    2. Damiano Brigo & Massimo Morini & Marco Tarenghi, 2009. "Credit Calibration with Structural Models: The Lehman case and Equity Swaps under Counterparty Risk," Papers 0912.4404, arXiv.org.
    3. Damiano Brigo & Cristin Buescu & Massimo Morini, 2011. "Impact of the first to default time on Bilateral CVA," Papers 1106.3496, arXiv.org.
    4. Li, Hui, 2010. "Downturn LGD: A Spot Recovery Approach," MPRA Paper 20010, University Library of Munich, Germany.
    5. Damiano Brigo & Mirela Predescu & Agostino Capponi, 2010. "Credit Default Swaps Liquidity modeling: A survey," Papers 1003.0889, arXiv.org, revised Mar 2010.
    6. 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, arXiv.org, revised Jun 2012.
    7. Damiano Brigo & Andrea Pallavicini & Vasileios Papatheodorou, 2009. "Bilateral counterparty risk valuation for interest-rate products: impact of volatilities and correlations," Papers 0911.3331, arXiv.org, revised Feb 2010.
    8. Calice, Giovanni, 2011. "The Impact of Collateral Policies on Sovereign CDS Spreads," ECMI Papers 12234, Centre for European Policy Studies.
    9. Harb, Etienne & Louhichi, Wael, 2017. "Pricing CDS spreads with Credit Valuation Adjustment using a mixture copula," Research in International Business and Finance, Elsevier, vol. 39(PB), pages 963-975.
    10. Damiano Brigo & Nicola Pede & Andrea Petrelli, 2019. "Multi-Currency Credit Default Swaps," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(04), pages 1-35, June.
    11. Cetina, Jill & Paddrik, Mark & Rajan, Sriram, 2018. "Stressed to the core: Counterparty concentrations and systemic losses in CDS markets," Journal of Financial Stability, Elsevier, vol. 35(C), pages 38-52.
    12. D’Errico, Marco & Battiston, Stefano & Peltonen, Tuomas & Scheicher, Martin, 2018. "How does risk flow in the credit default swap market?," Journal of Financial Stability, Elsevier, vol. 35(C), pages 53-74.
    13. 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, arXiv.org, revised Dec 2011.
    14. Zhou, Richard, 2010. "Counterparty Risk Subject To ATE," MPRA Paper 28067, University Library of Munich, Germany.
    15. Chris Kenyon & Andrew Green, 2016. "Option-Based Pricing of Wrong Way Risk for CVA," Papers 1609.00819, arXiv.org, revised Oct 2021.
    16. Simonella, Roberta & Vázquez, Carlos, 2023. "XVA in a multi-currency setting with stochastic foreign exchange rates," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 207(C), pages 59-79.
    17. Arndt Claußen & Sebastian Löhr & Daniel Rösch, 2014. "An analytical approach for systematic risk sensitivity of structured finance products," Review of Derivatives Research, Springer, vol. 17(1), pages 1-37, April.
    18. Damiano Brigo & Qing Liu & Andrea Pallavicini & David Sloth, 2014. "Nonlinear Valuation under Collateral, Credit Risk and Funding Costs: A Numerical Case Study Extending Black-Scholes," Papers 1404.7314, arXiv.org.
    19. Arregui, Iñigo & Salvador, Beatriz & Vázquez, Carlos, 2017. "PDE models and numerical methods for total value adjustment in European and American options with counterparty risk," Applied Mathematics and Computation, Elsevier, vol. 308(C), pages 31-53.
    20. Akari, Mohamed-Ali & Ben-Abdallah, Ramzi & Breton, Michèle & Dionne, Georges, 2021. "The impact of central clearing on the market for single-name credit default swaps," The North American Journal of Economics and Finance, Elsevier, vol. 56(C).

    More about this item

    Keywords

    ;
    ;
    ;
    ;
    ;
    ;
    ;
    ;
    ;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:19684. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Joachim Winter (email available below). General contact details of provider: https://edirc.repec.org/data/vfmunde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.