An Accurate Solution for Credit Valuation Adjustment and Wrong Way Risk

Tim Xiao

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Abstract: This paper presents a Least Square Monte Carlo approach for accurately calculating credit value adjustment (CVA). In contrast to previous studies, the model relies on the probability distribution of a default time/jump rather than the default time itself, as the default time is usually inaccessible. As such, the model can achieve a high order of accuracy with a relatively easy implementation. We find that the valuation of a defaultable derivative is normally determined via backward induction when their payoffs could be positive or negative. Moreover, the model can naturally capture wrong or right way risk. Acknowledge: The data were provided by FinPricing at www.finpricing.com/lib/IrSwap.html Key Words: credit value adjustment (CVA), wrong way risk, right way risk, credit risk modeling, least square Monte Carlo, default time approach (DTA), default probability approach (DPA), collateralization, margin and netting. 1 The views expressed here are of the author alone and not necessarily of his host institution.

Keywords: Capital Markets; Risk Quant; CIBC; Canada; Toronto (search for similar items in EconPapers)
Date: 2015-06-30
Note: View the original document on HAL open archive server: https://hal.science/hal-01810490v1
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Citations: View citations in EconPapers (7)

Published in Journal of fixed income, 2015, 25 (1), pp.84 - 95. ⟨10.3905/jfi.2015.25.1.084⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-01810490

DOI: 10.3905/jfi.2015.25.1.084

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