An Accurate Solution for Credit Value Adjustment (CVA) and Wrong Way Risk
Risk Models, BMO Capital Markets
May 1, 2013
This paper presents a new framework for credit value adjustment (CVA) that is a relatively new area of financial derivative modeling and trading. In contrast to previous studies, the model relies on the probability distribution of a default time/jump rather than the default time itself, as the default time is usually inaccessible. As such, the model can achieve a high order of accuracy with a relatively easy implementation. We find that the prices of risky contracts are normally determined via backward induction when their payoffs could be positive or negative. Moreover, the model can naturally capture wrong or right way risk.
Number of Pages in PDF File: 25
Keywords: credit value adjustment (CVA), wrong way risk, right way risk, credit risk modeling, risky valuation, default time approach (DTA), default probability approach (DPA), collateralization, margin and netting
JEL Classification: E44, G21, G12, G24, G32, G33, G18, G28working papers series
Date posted: May 21, 2013 ; Last revised: June 3, 2013
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