Counterparty risk for CDS: Default clustering effects

Lijun Bo and Agostino Capponi

Journal of Banking & Finance, 2015, vol. 52, issue C, 29-42

Abstract: We derive a closed-form expression for the bilateral credit valuation adjustment of a credit default swap in presence of simultaneous defaults. We develop our analysis under a default intensity model specified by a class of three-dimensional subordinators, allowing for default dependence through common risk factors. We performance a suitable decomposition of the bilateral price into debit and credit valuation adjustment components. Those components do not have a symmetric impact on the price because of the joint event occurrences. Our analysis indicates that simultaneous defaults have material impact on the size and directionality of the adjustments. Our findings suggest policymakers to consider default clustering when designing counterparty valuation procedures, especially during periods of financial distress.

Keywords: Counterparty risk; Simultaneous defaults; Multivariate subordinators; Credit default swaps (search for similar items in EconPapers)
JEL-codes: C15 C63 C65 G12 G13 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:52:y:2015:i:c:p:29-42

DOI: 10.1016/j.jbankfin.2014.11.010

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