NUMERICAL PROCEDURES FOR A WRONG WAY RISK MODEL WITH LOGNORMAL HAZARD RATES AND GAUSSIAN INTEREST RATES

Leslie Ng ()
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Leslie Ng: Markit, 1285 West Pender Street, 8th Floor, Vancouver, British Columbia V6E 4B1, Canada

International Journal of Theoretical and Applied Finance (IJTAF), 2013, vol. 16, issue 08, 1-33

Abstract: In this work, we present some numerical procedures for a wrong way risk model that can be used for credit value adjustment (CVA) calculations. We look at a model that uses a multi-factor Hull–White model for interest rates and a single-factor lognormal Black–Karasinski default intensity model for counterparty credit, where the default intensity driver is correlated with all interest rate drivers. We describe how a trinomial tree-based approach for implementing single factor short rate models by Hull and White (1994) can be modified and used to calibrate the intensity model to credit default swaps (CDSs) in the presence of correlation. We also provide approximate pricing methods for CDS options and single swap contingent CDS contracts. The latter methods could also be used for model calibration purposes subject to data availability.

Keywords: Stochastic intensity; credit value adjustment; wrong way risk; Black–Karasinski model; Hull–White multi-factor interest rate model; credit default swaps (search for similar items in EconPapers)
Date: 2013
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DOI: 10.1142/S0219024913500490

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