RT Journal Article
SR Electronic
T1 An Accurate Solution for Credit Value Adjustment (CVA) and Wrong Way Risk
JF The Journal of Fixed Income
FD Institutional Investor Journals
SP 84
OP 95
DO 10.3905/jfi.2015.25.1.084
VO 25
IS 1
A1 Tim Xiao
YR 2015
UL https://pm-research.com/content/25/1/84.abstract
AB This article presents a new framework for credit value adjustment (CVA) that is a relatively new area of financial derivative modeling and trading. In contrast to previous studies, the model relies on the probability distribution of a default time rather than the default time itself, as the default time is usually inaccessible. As such, the model can achieve a high order of accuracy and is relatively easy to implement. The model captures wrong-way or right-way risk naturally. Using a unique dataset, the author finds empirical evidence that wrong- or right-way risk has a material effect on risky valuation and CVA. The magnitude of the impact is greater in credit and equity markets. The results also indicate that diversification is an effective way to mitigate wrong- or right-way risk.TOPICS: VAR and use of alternative risk measures of trading risk, counterparty risk