A Copula Approach to CVA Modeling

17 Pages Posted: 4 Nov 2015

See all articles by Jakub Cerny

Jakub Cerny

Charles University in Prague - Faculty of Mathematics and Physics

Jiri Witzany

University of Economics in Prague

Date Written: November 2, 2015

Abstract

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 [2014], is further replaced by Fréchet copula (for extreme dependence) mainly based on the work of Cherubini [2013], 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

Suggested Citation

Cerny, Jakub and Witzany, Jiri, A Copula Approach to CVA Modeling (November 2, 2015). Available at SSRN: https://ssrn.com/abstract=2685413 or http://dx.doi.org/10.2139/ssrn.2685413

Jakub Cerny (Contact Author)

Charles University in Prague - Faculty of Mathematics and Physics ( email )

Sokolovska 83
Prague, 186 75
Czech Republic

Jiri Witzany

University of Economics in Prague ( email )

Winston Churchilla Sq. 4
Prague 3, 130 67
Czech Republic

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