Wrong-way risk adjusted exposure: analytical approximations for options in default intensity models

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Title: Wrong-way risk adjusted exposure: analytical approximations for options in default intensity models
Authors: Brigo, D
Hvolby, T
Vrins, F
Item 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.
Issue Date: 5-Apr-2017
Date of Acceptance: 20-Feb-2018
URI: http://hdl.handle.net/10044/1/58321
Publisher: World Scientific Publishing Co.
Journal / Book Title: Innovations in Insurance, Risk- and Asset Management
Copyright Statement: This paper is embargoed until publication.
Conference Name: Innovations in Insurance, Risk- and Asset Management
Publication Status: Accepted
Start Date: 2017-04-05
Finish Date: 2018-04-07
Conference Place: Munich, Germany
Embargo Date: publication subject to indefinite embargo
Appears in Collections:Financial Mathematics
Mathematics
Faculty of Natural Sciences



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