Wrong-way Risk in Credit Valuation Adjustment of Credit Default Swap with Copulas

Tetsuya Adachi, Takumi Sueshige and Toshinao Yoshiba
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Tetsuya Adachi: Economist, Institute for Monetary and Economic Studies, Bank of Japan (currently, PwC Consulting LLC, E-mail: tetsuya. adachi@pwc.com)
Takumi Sueshige: Senior, EY Shinnihon LLC (currently, School of Computing, Tokyo Institute of Technology, E-mail: sueshige.t.aa@m.titech.ac.jp)
Toshinao Yoshiba: Director and Senior Economist, Institute for Monetary and Economic Studies (currently, Financial System and Bank Examination Department), Bank of Japan (E-mail: toshinao.yoshiba@boj.or.jp)

No 19-E-01, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: We compare several wrong-way risk models for the credit valuation adjustment of a credit default swap under a copula approach with stochastic default intensities. We show that the tail dependent copulas well capture the wrong-way risk for the credit valuation adjustment. To that end, we employ an affine jump diffusion process for the default intensity to derive the distribution function of the cumulative intensity, based on the copula approach. To reduce computing time, we propose an approximation method using the fractional fast Fourier transform and numerical integration to the characteristic function of the cumulative intensity.

Keywords: Credit valuation adjustment; Credit default swap; Affine jump diffusion; Fractional fast Fourier transform; Characteristic function (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2019-01
New Economics Papers: this item is included in nep-rmg
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