Adapting the CVA model to Leland's framework

P. Amster and A. P. Mogni

Papers from arXiv.org

Abstract: We consider the framework proposed by Burgard and Kjaer (2011) that derives the PDE which governs the price of an option including bilateral counterparty risk and funding. We extend this work by relaxing the assumption of absence of transaction costs in the hedging portfolio by proposing a cost proportional to the amount of assets traded and the traded price. After deriving the nonlinear PDE, we prove the existence of a solution for the corresponding initial-boundary value problem. Moreover, we develop a numerical scheme that allows to find the solution of the PDE by setting different values for each parameter of the model. To understand the impact of each variable within the model, we analyze the Greeks of the option and the sensitivity of the price to changes in all the risk factors.

Date: 2018-02
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