Pricing Financial Derivatives Subject to Counterparty Risk and Credit Value Adjustment

David Lee

MPRA Paper from University Library of Munich, Germany

Abstract: This article presents a generic model for pricing financial derivatives subject to counterparty credit risk. Both unilateral and bilateral types of credit risks are considered. Our study shows that credit risk should be modeled as American style options in most cases, which require a backward induction valuation. To correct a common mistake in the literature, we emphasize that the market value of a defaultable derivative is actually a risky value rather than a risk-free value. Credit value adjustment (CVA) is also elaborated. A practical framework is developed for pricing defaultable derivatives and calculating their CVAs at a portfolio level.

Keywords: credit value adjustment (CVA); credit risk modeling; financial derivative valuation; collateralization; margin and netting. (search for similar items in EconPapers)
JEL-codes: C15 C53 C63 D46 E37 G12 G13 G17 (search for similar items in EconPapers)
Date: 2018-03-28
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Related works:
Working Paper: Pricing Financial Derivatives Subject to Counterparty Risk and Credit Value Adjustment (2018)
Working Paper: Pricing Financial Derivatives Subject to Counterparty Risk and Credit Value Adjustment (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:85575

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