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Unilateral CVA for CDS in Contagion Model_with Volatilities and Correlation of Spread and Interest


  • Bao, Qunfang
  • Chen, Si
  • Liu, Guimei
  • Li, Shenghong


The price of financial derivative with unilateral counterparty credit risk can be expressed as the price of an otherwise risk-free derivative minus a credit value adjustment(CVA) component that can be seen as shorting a call option, which is exercised upon default of counterparty, on MtM of the derivative. Therefore, modeling volatility of MtM and default time of counterparty is key to quantification of counterparty risk. This paper models default times of counterparty and reference with a particular contagion model with stochastic intensities that is proposed by Bao et al. 2010. Stochastic interest rate is incorporated as well to account for positive correlation between spread and interest. Survival measure approach is adopted to calculate MtM of risk-free CDS and conditional survival probability of counterparty in defaultable environment. Semi-analytical solution for CVA is attained. Affine specification of intensities and interest rate concludes analytical expression for pre-default value of MtM. Numerical experiments at the last of this paper analyze the impact of contagion, volatility and correlation on CVA.

Suggested Citation

  • Bao, Qunfang & Chen, Si & Liu, Guimei & Li, Shenghong, 2010. "Unilateral CVA for CDS in Contagion Model_with Volatilities and Correlation of Spread and Interest," MPRA Paper 26277, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:26277

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    References listed on IDEAS

    1. Bao, Qunfang & Li, Shenghong & Liu, Guimei, 2010. "Survival Measures and Interacting Intensity Model: with Applications in Guaranteed Debt Pricing," MPRA Paper 27698, University Library of Munich, Germany, revised 27 Dec 2010.
    2. P. Collin-Dufresne & R. Goldstein & J. Hugonnier, 2004. "A General Formula for Valuing Defaultable Securities," Econometrica, Econometric Society, vol. 72(5), pages 1377-1407, September.
    3. Philipp J. Schönbucher, 2000. "A Libor Market Model with Default Risk," Bonn Econ Discussion Papers bgse15_2001, University of Bonn, Germany.
    4. Kwai Leung & Yue Kwok, 2009. "Counterparty Risk for Credit Default Swaps: Markov Chain Interacting Intensities Model with Stochastic Intensity," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 16(3), pages 169-181, September.
    5. Robert A. Jarrow & Fan Yu, 2008. "Counterparty Risk and the Pricing of Defaultable Securities," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 20, pages 481-515 World Scientific Publishing Co. Pte. Ltd..
    6. Christophette Blanchet-Scalliet & Fr'ed'eric Patras, 2008. "Counterparty risk valuation for CDS," Papers 0807.0309,
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    More about this item


    Credit Value Adjustment; Contagion Model; Stochastic Intensities and Interest; Survival Measure; Affine Specification;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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