Model Independent WWR for Regulatory CVA and for Accounting CVA and FVA
17 Pages Posted: 27 Mar 2020
Date Written: March 2, 2020
Wrong way risk (WWR) is a consideration for regulatory capital for credit valuation adjustment (CVA). WWR is also of interest for pricing and accounting and in these cases must include funding as well as exposure and default in CVA and FVA calculation. Here we introduce a model independent approach to WWR for regulatory CVA and also for accounting CVA and FVA. This model independent approach is extremely simple: we just re-write the CVA and FVA integral expressions in terms of their components and then calibrate these components. This provides transparency between component calibration and CVA/FVA effect because there is no model interpretation in between. Including funding in WWR means that there are now two WWR terms rather than the usual one. Using a regulatory inspired calibration from MAR50 we investigate WWR effects for vanilla interest rate swaps and show that the WWR effects for FVA are significantly more material than for CVA. This model independent approach can also be used to compare any WWR model by simply calibrating to it for a portfolio and counterparty, to demonstrate the effects of the model under investigation in terms of components of CVA/FVA calculations.
Keywords: XVA, CVA, FVA, WWR, Accounting, Regulations, Capital, Funding, Default, Model Independent, Credit
JEL Classification: G11, G12, G13, G32, G33, E43, D81, D86, D52, C63, C61
Suggested Citation: Suggested Citation