An Accurate Solution for Credit Value Adjustment (CVA) and Wrong Way Risk

This paper 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/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 prices of risky contracts are normally determined via backward induction when their payoffs could be positive or negative. Moreover, the model can naturally capture wrong or right way risk.

Precautionary Measures for Credit Risk Management in Jump Models

Sustaining efficiency and stability by properly controlling the equity to asset ratio is one of the most important and difficult challenges in bank management. Due to unexpected and abrupt decline of asset values, a bank must closely monitor its net worth as well as market conditions, and one of its important concerns is when to raise more capital so as not to violate capital adequacy requirements. In this paper, we model the tradeoff between avoiding costs of delay and premature capital raising, and solve the corresponding optimal stopping problem. In order to model defaults in a bank's loan/credit business portfolios, we represent its net worth by Levy processes, and solve explicitly for the double exponential jump diffusion process and for a general spectrally negative Levy process.Comment: 31 pages, 4 figure

Copula-Based Default Dependence Modelling: Where Do We Stand?

Copula functions have proven to be extremely useful in describing joint default and survival probabilities in credit risk applications. We overview the state of the art and point out some open modelling issues. We discuss first joint default modelling in diffusion based structural models, then in intensity based ones, focusing on the possibility - and the dynamic inconsistency - of re-mapping a model of the second type into one of the first. For both types of models, we discuss calibration issues under the risk neutral measure, using the factor copula device. The survey leads us to focus on a non-diffusive structural model, which can be re-mapped in a dynamic consistent intensity-based one, and which can be calibrated under a risk neutral measure without assuming equicorrelation.default dependence, copula functions, risk neutral versus historical dependence

Modeling basket credit default swaps with default contagion

The specification of a realistic dependence structure is key to the pricing of multi-name credit derivatives. We value small kth-to-default CDS baskets in the presence of asset correlation and default contagion. Using a first-passage framework, firm values are modeled as correlated geometric Brownian motions with exponential default thresholds. Idiosyncratic links between companies are incorporated through a contagion mechanism whereby a default event leads to jumps in volatility at related entities. Our framework allows for default causality and is extremely flexible, enabling us to evaluate the spread impact of firm value correlations and credit contagion for symmetric and asymmetric baskets

Impact of Financial Liberalization on Financial Depth in Iraq

This paper examines the Mackinnon-Show hypothesis i.e. financial liberalization promotes financial depth in case of Iraq. Iraq launched a comprehensive program of economic and financial liberalization since 2003. Thus, this paper aims to answer the key question that “is financial liberalization stimulated the financial depth in Iraq?”. By applying the ARDL Autoregressive Distributed Lag model on quarterly data during the period 2005- 2010, the paper finds that the liberalization of interest rates as a proxy of financial liberalization stimulated the financial depthonly in the long-run in the case of Iraq.