Counterparty Risk Valuation: A Marked Branching Diffusion Approach

Pierre Henry-Labordere
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Pierre Henry-Labordere: SOCIETE GENERALE

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Abstract: The purpose of this paper is to design an algorithm for the computation of the counterparty risk which is competitive in regards of a brute force "Monte-Carlo of Monte-Carlo" method (with nested simulations). This is achieved using marked branching diffusions describing a Galton-Watson random tree. Such an algorithm leads at the same time to a computation of the (bilateral) counterparty risk when we use the default-risky or counterparty-riskless option values as mark-to-market. Our method is illustrated by various numerical examples.

Date: 2012-03
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