Credit Value Adjustment with Market-Implied Recovery

42 Pages Posted: 28 Jun 2016 Last revised: 9 Oct 2017

See all articles by Pascal Francois

Pascal Francois

HEC Montreal - Department of Finance

Wei Yu Jiang

McGill University, Students

Date Written: October 6, 2017

Abstract

We present a model for CVA calculation in which the recovery rate is inferred from the term structure of CDS spreads. The negative relation between recovery rates and default probabilities induces a substantial underestimation of the CVA when constant recovery is assumed. That underestimation prevails for both unilateral and bilateral CVA as well as for the CVA capital charge. It gets more severe as the horizon of the position increases. Our CVA model with market-implied recovery also offers a way to capture correlation effects between the level of exposure and counterparty risk.

Keywords: CVA, Implied recovery, Credit risk, OTC derivatives

JEL Classification: G13, G20

Suggested Citation

Francois, Pascal and Jiang, Wei Yu, Credit Value Adjustment with Market-Implied Recovery (October 6, 2017). Available at SSRN: https://ssrn.com/abstract=2801078 or http://dx.doi.org/10.2139/ssrn.2801078

Pascal Francois (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-7743 (Phone)
514-340-5632 (Fax)

Wei Yu Jiang

McGill University, Students ( email )

Montréal, Quebec
Canada

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