The Valuation of Financial Derivatives Subject to Counterparty Risk and Credit Value Adjustment

Tim Xiao

EconStor Preprints from ZBW - Leibniz Information Centre for Economics

Abstract: This article presents a generic model for pricing financial derivatives subject to counterparty credit risk. Both unilateral and bilateral types of credit risks are considered. Our study shows that credit risk should be modeled as American style options in most cases, which require a backward induction valuation. To correct a common mistake in the literature, we emphasize that the market value of a defaultable derivative is actually a risky value rather than a risk-free value. Credit value adjustment (CVA) is also elaborated. A practical framework is developed for pricing defaultable derivatives and calculating their CVAs at a portfolio level.

Keywords: credit value adjustment (CVA); credit risk modeling; financial derivative valuation; collateralization; margin and netting (search for similar items in EconPapers)
JEL-codes: E44 G12 G18 G21 G24 G28 G32 G33 (search for similar items in EconPapers)
Date: 2019
New Economics Papers: this item is included in nep-cfn, nep-fmk, nep-mac and nep-rmg
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https://www.econstor.eu/bitstream/10419/204279/1/derivativeCVA%20-13.pdf (application/pdf)

Related works:
Working Paper: The Valuation of Financial Derivatives Subject to Counterparty Risk and Credit Value Adjustment (2020)
Working Paper: The Valuation of Financial Derivatives Subject to Counterparty Risk and Credit Value Adjustment (2020)
Working Paper: The Valuation of Financial Derivatives Subject to Counterparty Risk and Credit Value Adjustment (2019)
Working Paper: The Valuation of Financial Derivatives Subject to Counterparty Risk and Credit Value Adjustment (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:esprep:204279

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