Structural Counterparty Risk Valuation for Credit Default Swaps

Christophette Blanchet-Scalliet () and Frédéric Patras ()
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Christophette Blanchet-Scalliet: ICJ - Institut Camille Jordan - ECL - École Centrale de Lyon - Université de Lyon - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - INSA Lyon - Institut National des Sciences Appliquées de Lyon - Université de Lyon - INSA - Institut National des Sciences Appliquées - UJM - Université Jean Monnet - Saint-Étienne - CNRS - Centre National de la Recherche Scientifique
Frédéric Patras: JAD - Laboratoire Jean Alexandre Dieudonné - UNS - Université Nice Sophia Antipolis (1965 - 2019) - CNRS - Centre National de la Recherche Scientifique

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Abstract: The valuation of counterparty risk for single-name credit derivatives is often based on reduced models where defaults intensities drive the jump-to-default of the counterparty. Whereas efficient and relatively easy to calibrate to credit default swaps (CDS) spreads and market data, we argue that this approach should be supplemented by the structural approach familiar in multiname credit risk (e.g., in the Gaussian copula models or in many widespread credit portfolios risk assessment tools). We discuss Merton-type structural models for counterparty risk, their advantages, soundness, and potential shortcomings, and address the question of their numerical tractability.We focus then on the derivation of closed formulas for counterparty risk on a (possibly collateralized) CDS--extending the ones familiar in the pricing of multiname barrier options. Most of our results are meaningful more generally for derivatives on two default-prone assets: multiple barrier conditions or equity-to-credit modeling.

Date: 2011
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Published in Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity, WILEY, pp.437-456, 2011

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-00594194

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