A Copula Approach to CVA Modeling
17 Pages Posted: 4 Nov 2015
Date Written: November 2, 2015
We consider counterparty credit risk in the interest rate swap (IRS) contracts in the presence of an adverse dependence between the default time and interest rates, so-called wrong-way risk. The IRS credit valuation adjustment (CVA) semi-analytical formula based on Gaussian copula assumption, presented in Černý and Witzany , is further replaced by Fréchet copula (for extreme dependence) mainly based on the work of Cherubini , called modified approach. The result of all three CVA calculation approaches are compared in a numerical study where we find that our semi-analytical formulas (the Gaussian copula and modified approach) provide more accurate information on IRS CVA price.
Keywords: Counterparty Credit Risk, Credit Valuation Adjustment, Copulas, Wrong-way Risk, Interest Rate Swaps
JEL Classification: C63, G12, G13, G32
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