CVA of an Interest Rate Swap

Specialeforsvar ved Andreas Bøhlke

Titel: CVA pf am Omterest Rate Swap

Abstract: The enormous growth of the over-the-counter (OTC) derivatives market over the last decades has lead to increased focus on counterparty credit risk. The central concept in this context is the credit value adjustment (CVA), which can be seen as the market price of counterparty risk. CVA affects a financial institution across the entire business, why it is of great importance to mitigate and handle this risk properly. Motivated by this, we investigate CVA of an interest rate swap seen from a pricing perspective. Calculating CVA requires joint modelling of credit exposure and counterparty default. We develop a model/ framework for doing so, and to illustrate the use in practice, we show how the underlying models can easily be calibrated to market data. A common simplifying assumption among practitioners is, that exposure and probability of counterparty default is uncorrelated. Empirical studies reveal that this is far from true, and recent market developments have shown, that it can have severe consequences to disregard this dependence. Inspired by this, we try to incorporate correlation into the model, and investigate the possible consequences it can have when neglecting it 

Vejleder: David Skovmand
Censor:   Jesper Lund, CBS