Bilateral Credit Valuation Adjustment of an Optional Early Termination Clause
January 17, 2013
Is an option to early terminate a swap at its market value worth zero? At first sight it is, but in presence of counterparty risk it depends on the criteria used to determine such market value. In case of a single uncollateralised swap transaction under ISDA between two defaultable counterparties, the additional unilateral option to early terminate the swap at predefined dates requires a Bermudan credit valuation adjustment. We give a general pricing formula assuming a default-free close-out amount, and apply it in a simplified setting with deterministic intensity and one single date of optional early termination, showing that the impact on the fair value of the transaction at inception might be non negligible.
Number of Pages in PDF File: 10
Keywords: Counterparty risk, Credit Valuation Adjustment, Unilateral CVA, Bilateral CVA, Debit Valuation Adjustment, Closeout, ISDA, Bermudan option, Equity Forward Contract, Break clause, Optional Early Termination clause, Additional Early Termination clause, Gumbel bivariate exponential distributions
JEL Classification: G12, G13working papers series
Date posted: May 9, 2012 ; Last revised: January 23, 2013
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo4 in 2.125 seconds