Derivatives Pricing after the 2007-2008 Crisis: How the Crisis Changed the Pricing Approach
30 Pages Posted: 19 Oct 2014 Last revised: 20 Sep 2017
Date Written: September 19, 2017
This paper is a summary how to price a derivative product, in the context of fear of default due to the financial crisis. We explain how zero-coupon bond curves are built; we explain how to price a collateralized deal with the possibility of two choices of collateral to post; we explain how to compute both the unilateral and the bilateral Credit Valuation Adjustment (CVA). We introduce notions of Wrong-Way Risk (WWR) and Right-Way Risk (RWR). As application we provide some simulation results on the Interest Rate Swap (IRS) contract. Computations are performed in Monte Carlo.
Keywords: CSA, collateral, CVA, credit, exposure,Wrong-Way Risk (WWR), Right-Way Risk (RWR), yield curve, DVA, FVA, zero-coupon bond, rate, hazard rate, interest rate swap, cross currency swap, collateral basis, FX swap, Libor, OIS, hull and white, CIR, lognormal
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