VALUATION AND HEDGING OF CDS COUNTERPARTY EXPOSURE IN A MARKOV COPULA MODEL

T. R. Bielecki (), S. Crépey, M. Jeanblanc and B. Zargari
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T. R. Bielecki: Department of Applied Mathematics, Illinois Institute of Technology, 10 W 32nd Street, Chicago, IL 60616, USA
S. Crépey: Université d'Evry, Laboratoire d'Analyse & Probabilitiés, 23 Boulevard de France, 91037 Evry, France
M. Jeanblanc: Université d'Evry, Laboratoire d'Analyse & Probabilitiés, 23 Boulevard de France, 91037 Evry, France
B. Zargari: Université d'Evry, Laboratoire d'Analyse & Probabilitiés, 23 Boulevard de France, 91037 Evry, France;

International Journal of Theoretical and Applied Finance (IJTAF), 2012, vol. 15, issue 01, 1-39

Abstract: A Markov model is constructed for studying the counterparty risk in a CDS contract. The "wrong-way risk" in this model is accounted for by the possibility of the common default of the reference name and of the counterparty. A dynamic copula property as well as affine model specifications make pricing and calibration very efficient. We also consider the issue of dynamically hedging the CVA with a rolling CDS written on the counterparty. Numerical results are presented to show the adequacy of the behavior of CVA in the model with stylized features.

Keywords: Counterparty credit risk; CDS; CVA; wrong-way risk; dynamic hedging (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (7)

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DOI: 10.1142/S0219024911006498

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