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 and Sharif University of Technology, Tehran, Iran

Chapter 4 in Finance at Fields, 2012, pp 75-113 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractA 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: Mathematical Finance; Financial Mathematics; Risk Management; Asset Pricing; Computational Finance; Derivatives; Option Pricing; Portfolio Optimization (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (7)

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