COUNTERPARTY RISK AND FUNDING: THE FOUR WINGS OF THE TVA

Stéphane Crépey (), Rémi Gerboud, Zorana Grbac and Nathalie Ngor
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Stéphane Crépey: Laboratoire Analyse et Probabilités, Université d'Évry Val d'Essonne, 91037 Évry Cedex, France
Rémi Gerboud: Laboratoire Analyse et Probabilités, Université d'Évry Val d'Essonne, 91037 Évry Cedex, France
Zorana Grbac: Laboratoire Analyse et Probabilités, Université d'Évry Val d'Essonne, 91037 Évry Cedex, France
Nathalie Ngor: Laboratoire Analyse et Probabilités, Université d'Évry Val d'Essonne, 91037 Évry Cedex, France

International Journal of Theoretical and Applied Finance (IJTAF), 2013, vol. 16, issue 02, 1-31

Abstract: The credit crisis and the ongoing European sovereign debt crisis have highlighted the native form of credit risk, namely the counterparty risk. The related credit valuation adjustment (CVA), debt valuation adjustment (DVA), liquidity valuation adjustment (LVA) and replacement cost (RC) issues, jointly referred to in this paper as total valuation adjustment (TVA), have been thoroughly investigated in the theoretical papers [8, 9]. The present work provides an executive summary and numerical companion to these papers, through which the TVA pricing problem can be reduced to Markovian pre-default TVA BSDEs. The first step consists in the counterparty clean valuation of a portfolio of contracts, which is the valuation in a hypothetical situation where the two parties would be risk-free and funded at a risk-free rate. In the second step, the TVA is obtained as the value of an option on the counterparty clean value process called contingent credit default swap (CCDS). Numerical results are presented for interest rate swaps in the Vasicek, as well as in the inverse Gaussian Hull-White short rate model, which allows also to assess the related model risk issue.

Keywords: Counterparty risk; credit valuation adjustment (CVA); debt valuation adjustment (DVA); liquidity valuation adjustment (LVA); backward stochastic differential equation (BSDE); interest rate swap (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (11)

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DOI: 10.1142/S0219024913500064

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