Stochastic Intensity Models of Wrong Way Risk: Wrong Way CVA Need Not Exceed Independent CVA

Posted: 20 May 2019

See all articles by Samim Ghamami

Samim Ghamami

University of California, Berkeley - Center for Risk Management Research; New York University (NYU); Goldman Sachs Group, Inc.

Lisa R. Goldberg

University of California, Berkeley; Aperio Group

Date Written: October 8, 2013

Abstract

Wrong way risk can be incorporated in Credit Value Adjustment (CVA) calculations in a reduced form model. Hull and White (2012) introduced a CVA model that captures wrong way risk by expressing the stochastic intensity of a counterparty's default time in terms of the financial institution's credit exposure to the counterparty. We consider a class of reduced form CVA models that includes the formulation of Hull and White and show that wrong way CVA need not exceed independent CVA. This result is based on some general properties of the model calibration scheme and a formula that we derive for intensity models of dependent CVA (wrong or right way). We support our result with a stylized analytical example as well as more realistic numerical examples based on the Hull and White model. We conclude with a discussion of the implications of our findings for Basel III CVA capital charges, which are predicated on the assumption that wrong way risk increases CVA.

Keywords: Credit Value Adjustment, Wrong Way Risk, Basel III CVA Capital Charges, Stochastic Intensity Modeling

JEL Classification: C1, G1

Suggested Citation

Ghamami, Samim and Goldberg, Lisa R., Stochastic Intensity Models of Wrong Way Risk: Wrong Way CVA Need Not Exceed Independent CVA (October 8, 2013). https://doi.org/10.3905/jod.2014.21.3.024. Available at SSRN: https://ssrn.com/abstract=2337626 or http://dx.doi.org/10.2139/ssrn.2337626

Samim Ghamami (Contact Author)

University of California, Berkeley - Center for Risk Management Research ( email )

581 Evans Hall
Berkely, CA 94720
United States

New York University (NYU) ( email )

Bobst Library, E-resource Acquisitions
20 Cooper Square 3rd Floor
New York, NY 10003-711
United States

Goldman Sachs Group, Inc. ( email )

85 Broad Street
New York, NY 10004
United States

Lisa R. Goldberg

University of California, Berkeley ( email )

Department of Statistics
367 Evans Hall
Berkeley, CA 94720-3860
United States

Aperio Group ( email )

3 Harbor Drive
Suite 315
Sausalito, CA 94965
United States

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