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Credit Derivative Evaluation and CVA Under the Benchmark Approach

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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Asia-Pacific Financial Markets Springer Journals

Credit Derivative Evaluation and CVA Under the Benchmark Approach

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Publisher
Springer Journals
Copyright
Copyright © 2015 by Springer Japan
Subject
Economics / Management Science; Finance/Investment/Banking; Financial Economics; International Economics; Econometrics; Economic Theory
ISSN
1387-2834
eISSN
1573-6946
DOI
10.1007/s10690-015-9204-4
Publisher site
See Article on Publisher Site

Abstract

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.

Journal

Asia-Pacific Financial Markets – Springer Journals

Published: Apr 5, 2015

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