Wrong Way Risk Done Right

15 Pages Posted: 2 Feb 2015

See all articles by Shinghoi (Jacky) Lee

Shinghoi (Jacky) Lee

Quantitative Strategies - Investment Banking Division - Credit Suisse Group

Luca Capriotti

University College London; NYU Polytechnic School of Engineering - Department of Finance and Risk Engineering

Date Written: February 1, 2015

Abstract

We present an arbitrage-free valuation framework for the counterparty exposure of credit derivatives portfolios based on a Clayton dynamical default dependency approach. The method is able to capture consistently the effects of credit spread volatility and credit correlations. By introducing fast semi-analytical approximations of the conditional survival probabilities we demonstrate how the proposed approach can be used to handle large size portfolios of CDS under financially realistic models of default intensities.

Keywords: wrong way risk, counterparty risk, XVA, credit derivatives, Clayton copula, default intensity models

Suggested Citation

Lee, Shinghoi (Jacky) and Capriotti, Luca, Wrong Way Risk Done Right (February 1, 2015). Available at SSRN: https://ssrn.com/abstract=2558766 or http://dx.doi.org/10.2139/ssrn.2558766

Shinghoi (Jacky) Lee

Quantitative Strategies - Investment Banking Division - Credit Suisse Group ( email )

Eleven Madison Avenue
New York, NY 10010
United States

Luca Capriotti (Contact Author)

University College London ( email )

Gower Street
London, WC1E 6BT
United Kingdom

NYU Polytechnic School of Engineering - Department of Finance and Risk Engineering ( email )

Brooklyn, NY 11201
United States

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