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CVA for Cliquet options under Heston model

Yaqin Feng, Min Wang and Yuanqing Zhang

The North American Journal of Economics and Finance, 2019, vol. 48, issue C, 272-282

Abstract: Credit value adjustment (CVA) is an important pricing component in the counterparty credit risk (CCR) management. Cliquet options are a popular volatility product with protection against downside risk as well as significant upside potential. This paper aims to study the CVA for Cliquet options under stochastic volatility models. A partial differential equation (PDE) is first derived to price Cliquet options under the Heston model. Numerical schemes are then provided to solve the PDE and calculate exposure and CVA. Numerical tests are also carried out to examine the scheme accuracy and impacts of wrong way risk to CVA. Test results show that the numerical schemes are accurate. Wrong way risk plays an important role in pricing CVA for Cliquet options and the impact is crucial from the perspective of CCR management.

Keywords: Counterparty credit risk; Credit value adjustment; Cliquet option; Stochastic volatility; Heston model; PDE (search for similar items in EconPapers)
Date: 2019
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Handle: RePEc:eee:ecofin:v:48:y:2019:i:c:p:272-282