Jumping with default: wrong-way risk modelling for CVA
Fabio Mercurio and Minqiang Li investigate credit valuation adjustments (CVAs) in the presence of wrong-way risk by introducing jumps at default to model the correlation between counterparty default and relevant risk factors. Efficient approximations based on CVA formulas with the independence assumption are presented, and numerical examples for a cross-currency swap and a vanilla interest rate swap are showcased
Credit valuation adjustment (CVA) is widely recognised as one of the most important credit risk measures by industry practitioners and regulators. Traditional CVA calculations were – and to a great extent still are – based on an assumption of independence between default and market risk factors. However, there has been a growing consensus that wrong-way risk (WWR) should also be taken into account.WWR is defined as the event that occurs when exposure to a counterparty is adversely correlated
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