Wrong Way Risk Done Right
15 Pages Posted: 2 Feb 2015
Date Written: February 1, 2015
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
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