4,247 research outputs found
The Impact of Default Dependency and Collateralization on Asset Pricing and Credit Risk Modeling
This article presents a comprehensive framework for valuing financial instruments subject to credit risk and collateralization. In particular, we focus on the impact of default dependence on asset pricing, as correlated default risk is one of the most pervasive threats to financial markets. Some well-known risky valuation models in the markets can be viewed as special cases of this framework. We introduce the concept of comvariance (or comrelation) into the area of credit risk modeling to capture the default relationship among three or more parties. Accounting for default correlations and comrelations becomes important, especially during the credit crisis. Moreover, we find that collateralization works well for financial instruments subject to bilateral credit risk, but fails for ones subject to multilateral credit risk
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.
CCPs, Central Clearing, CSA, Credit Collateral and Funding Costs Valuation FAQ: Re-hypothecation, CVA, Closeout, Netting, WWR, Gap-Risk, Initial and Variation Margins, Multiple Discount Curves, FVA?
We present a dialogue on Funding Costs and Counterparty Credit Risk modeling,
inclusive of collateral, wrong way risk, gap risk and possible Central Clearing
implementation through CCPs. This framework is important following the fact
that derivatives valuation and risk analysis has moved from exotic derivatives
managed on simple single asset classes to simple derivatives embedding the new
or previously neglected types of complex and interconnected nonlinear risks we
address here. This dialogue is the continuation of the "Counterparty Risk,
Collateral and Funding FAQ" by Brigo (2011). In this dialogue we focus more on
funding costs for the hedging strategy of a portfolio of trades, on the
non-linearities emerging from assuming borrowing and lending rates to be
different, on the resulting aggregation-dependent valuation process and its
operational challenges, on the implications of the onset of central clearing,
on the macro and micro effects on valuation and risk of the onset of CCPs, on
initial and variation margins impact on valuation, and on multiple discount
curves. Through questions and answers (Q&A) between a senior expert and a
junior colleague, and by referring to the growing body of literature on the
subject, we present a unified view of valuation (and risk) that takes all such
aspects into account
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