In many financial contracts (and in particular when trading OTC derivatives), participants
are exposed to counterparty risk. The latter is typically rewarded by adjusting the “risk-free
price” of derivatives; an adjustment known as
credit value adjustment
(CVA). A key driver
of CVA is the dependency between exposure and counterparty risk, known as
wrong-way risk
(WWR). In practice however, correctly addressing WWR is very challenging and calls for
heavy numerical techniques. This might explain why WWR is not explicitly handled in the
Basel III regulatory framework in spite of its acknowledged importance. In this paper we
propose a sound and tractable method to deal efficiently with WWR. Our approach consists
of embedding the WWR effect in the drift of the exposure dynamics. Even though this
calls for infinite changes of measures, we end up with an appealing compromise between
tractability and mathematical rigor, preserving the level of accuracy typically required for
CVA figures. The good performances of the method are discussed in a stochastic-intensity
default setup based on extensive comparisons of Expected Positive Exposure (EPE) profiles
and CVA figures produced (i) by a full bivariate Monte Carlo implementation of the initial
model with (ii) our drift-adjustment technique.