Counterparty Risk Valuation for Energy-Commodities Swaps: Impact of Volatilities and Correlation

21 Pages Posted: 24 Jun 2008

See all articles by Damiano Brigo

Damiano Brigo

Imperial College London - Department of Mathematics

Kyriakos Chourdakis

FitchSolutions; CCFEA

Imane Bakkar

Fitch Ratings Inc. - FitchSolutions

Date Written: June 24, 2008

Abstract

It is commonly accepted that Commodities futures and forward prices, in principle, agree under some simplifying assumptions. One of the most relevant assumptions is the absence of counterparty risk. Indeed, due to margining, futures have practically no counterparty risk. Forwards, instead, may bear the full risk of default for the counterparty when traded with brokers or outside clearing houses, or when embedded in other contracts such as swaps. In this paper we focus on energy commodities and on Oil in particular. We use a hybrid commodities-credit model to assess impact of counterparty risk in pricing formulas, both in the gross effect of default probabilities and on the subtler effects of credit spread volatility, commodities volatility and credit-commodities correlation. We illustrate our general approach with a case study based on an oil swap, showing that an accurate valuation of counterparty risk depends on volatilities and correlation and cannot be accounted for precisely through a pre-defined multiplier.

Keywords: Counterparty Risk, Credit Valuation adjustment, Commodities, Swaps, Oil models, Convenience Yield models, Stochastic Intensity models

JEL Classification: C15, C63, C65, G12, G13

Suggested Citation

Brigo, Damiano and Chourdakis, Kyriakos and Bakkar, Imane, Counterparty Risk Valuation for Energy-Commodities Swaps: Impact of Volatilities and Correlation (June 24, 2008). Available at SSRN: https://ssrn.com/abstract=1150818 or http://dx.doi.org/10.2139/ssrn.1150818

Damiano Brigo (Contact Author)

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www.imperial.ac.uk/people/damiano.brigo

Kyriakos Chourdakis

FitchSolutions ( email )

101 Finsbury Pavement
London
United Kingdom

CCFEA ( email )

Wivenhoe Park
Colchester, Essex CO4 3SQ
United Kingdom

Imane Bakkar

Fitch Ratings Inc. - FitchSolutions

101 Finsbury Pavement
London
United Kingdom

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