Credit Derivative Evaluation and CVA under the Benchmark Approach
In this paper, we discuss how to model credit risk under the benchmark approach. Firstly we introduce an affine credit risk model. We then show how to price credit default swaps (CDSs) and introduce credit valuation adjustment (CVA) as an extension of CDSs. In particular, our model can capture right-way - and wrong-way exposure. This means, we capture the dependence structure of the default event and the value of the transaction under consideration. For simple contracts, we provide closed-form solutions. However, due to the fact that we allow for a dependence between the default event and the value of the transaction, closed-form solutions are difficult to obtain in general. Hence we conclude this paper with a reduced form model, which is more tractable.
|Date of creation:||01 Feb 2013|
|Date of revision:|
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- 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.
- Eckhard Platen, 2002. "A Benchmark Framework for Integrated Risk Management," Research Paper Series 82, Quantitative Finance Research Centre, University of Technology, Sydney.
- Eckhard Platen, 2006.
"A Benchmark Approach To Finance,"
Wiley Blackwell, vol. 16(1), pages 131-151.
- Eckhard Platen & Renata Rendek, 2010. "Approximating the Numeraire Portfolio by Naive Diversification," Research Paper Series 281, Quantitative Finance Research Centre, University of Technology, Sydney.
- Dan Tang & Yongjin Wang & Yuzhen Zhou, 2011. "Counterparty Risk For Credit Default Swap With States Related Default Intensity Processes," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 14(08), pages 1335-1353.
- 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.
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