Wrong-way risk adjusted exposure: analytical approximations for options in default intensity models
File(s)
Published version
Author(s)
Brigo, D
Hvolby, Thomas
Vrins, Frederic
Type
Conference Paper
Abstract
We examine credit value adjustment (CVA) estimation under wrong-way risk
(WWR) by computing the expected positive exposure (EPE) under an equiva-
lent measure as suggested in [1], adjusting the drift of the underlying for default
risk. We apply this technique to European put and call options and derive the
analytic formulas for EPE under WWR obtained with various approximations
of the drift adjustment. We give the results of numerical experiments based
on 4 parameter sets, and supply figures of the CVA based on both of the sug-
gested proxys, comparing with CVA based on a 2D-Monte Carlo scheme and
Gaussian Copula resampling. We also show the CVA obtained by the formulas
from Basel III. We observe that the Basel III formula does not account for
the credit-market correlation, while the Gaussian Copula resampling method
estimates a too large impact of this correlation. The two proxies account for
the credit-market correlation, and give results that are mostly similar to the
2D-Monte Carlo results.
(WWR) by computing the expected positive exposure (EPE) under an equiva-
lent measure as suggested in [1], adjusting the drift of the underlying for default
risk. We apply this technique to European put and call options and derive the
analytic formulas for EPE under WWR obtained with various approximations
of the drift adjustment. We give the results of numerical experiments based
on 4 parameter sets, and supply figures of the CVA based on both of the sug-
gested proxys, comparing with CVA based on a 2D-Monte Carlo scheme and
Gaussian Copula resampling. We also show the CVA obtained by the formulas
from Basel III. We observe that the Basel III formula does not account for
the credit-market correlation, while the Gaussian Copula resampling method
estimates a too large impact of this correlation. The two proxies account for
the credit-market correlation, and give results that are mostly similar to the
2D-Monte Carlo results.
Date Acceptance
2018-02-20
Citation
Innovations in Insurance, Risk- and Asset Management
Publisher
World Scientific Publishing Co.
Journal / Book Title
Innovations in Insurance, Risk- and Asset Management
Copyright Statement
Open Access chapter published by World Scientific Publishing Company and distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives(CC BY-NC 4.0) License.
Source
Innovations in Insurance, Risk- and Asset Management
Publication Status
Accepted
Start Date
2017-04-05
Finish Date
2018-04-07
Coverage Spatial
Munich, Germany