Li, Hui (2009): Double Impact on CVA for CDS: Wrong-Way Risk with Stochastic Recovery.
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Abstract
Current CVA modeling framework has ignored the impact of stochastic recovery rate. Due to the possible negative correlation between default and recovery rate, stochastic recovery rate could have a doubling effect on wrong-way risk. In the case of a payer CDS, when counterparty defaults, the CDS value could be higher due to default contagion while the recovery rate may also be lower if the economy is in a downturn. Using our recently proposed model of correlated stochastic recovery in the default time Gaussian Copula framework, we demonstrate this double impact on wrong-way risk in the CVA calculation for a payer CDS. We also present a new form of Gaussian copula that correlates both default time and recovery rate.
Item Type: | MPRA Paper |
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Original Title: | Double Impact on CVA for CDS: Wrong-Way Risk with Stochastic Recovery |
Language: | English |
Keywords: | Counterparty Risk, Credit Valuation Adjustment, Wrong-Way Risk, Default Time Copula, Gaussian Copula, Default Correlation, Stochastic Recovery, Spot Recovery, Credit Default Swap |
Subjects: | G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing |
Item ID: | 19684 |
Depositing User: | Hui Li |
Date Deposited: | 05 Jan 2010 11:34 |
Last Modified: | 01 Oct 2019 04:16 |
References: | [1] E. Altman (2006): Default Recovery Rates and LGD in the Credit Risk Model and Practice: An Updated Review of the Literature and Empirical Evidence. defaultrisk.com. [2] S. Assefa, T. Bielecki, S. Crepey and M. Jeanblanc (2009): CVA computation for counterparty risk assessment in credit portfolio. defaultrisk.com. [3] Basel Committee on Banking Supervision: Strengthening the resilience of banking sector. Bank of International Settlements, December 2009. [4] N. Bennani and J. Maetz (2009): A Spot Recovery Rate Extension of the Gaussian Copula. defaultrisk.com. [5] C. Blanchet-Scalliet and F. Patras (2008): Counterparty Risk Valuation for CDS. defaultrisk.com. [6] D. Brigo and K. Chourdakis (2008): Counterparty Risk for Credit Default Swaps: Impact of spread volatility and default correlation. defaultrisk.com. [7] D. Brigo and A. Capponi (2009): Bilateral counterparty risk valuation with stochastic dynamic models and application to Credit Default Swaps. defaultrisk.com. [8] S. Crepey, M. Jeanblanc and B. Zargari (2009): Counterparty Risk on a CDS in a Markov Chain Copula Model with Joint Defaults. defaultrisk.com. [9] S. Hitier and E. Huber (2009): CDO Pricing: Copula Implied by Risk Neutral Dynamics. defaultrisk.com. [10] D. X. Li (2000): On Default Correlation: A Copula Function Approach. Working Paper, Nr. 99-07, RiskMetrics. [11] H. Li (2008): CVA calculation for CDS on super senior ABS CDO. defaultrisk.com. [12] H. Li (2009): On Models of Stochastic Recovery for Base Correlation. http://mpra.ub.uni-muenchen.de/17894 [13] H. Li (2009): Extension of Spot Recovery Model for Gaussian Copula. defaultrisk.com. [14] A. Lipton and A. Sepp (2009): Credit value adjustment for credit default swaps via the structural default model. Journal of Credit Risk, Vol 5, No. 2, pp 123-146. |
URI: | https://mpra.ub.uni-muenchen.de/id/eprint/19684 |
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