2009/11/17 by Damiano Brigo, Brigo, Damiano, Andrea Pallavicini +3
Economics, Econometrics and Finance · Social Sciences · #Computational Finance (q-fin.CP) #Credit Risk and Financial Regulations #FOS: Economics and business #Insurance, Mortality, Demography, Risk Management #Pricing of Securities (q-fin.PR) #Stochastic processes and financial applications #q-fin.CP #q-fin.PR
paper · pdf · doi:10.48550/arxiv.0911.3331
23 pages, 2 figures
openalex publication_date 2009/11/17 · arxiv created 2010/02/03 · arxiv updated 2010/02/08 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/28
The purpose of this paper is introducing rigorous methods and formulas for bilateral counterparty risk credit valuation adjustments (CVA's) on interest-rate portfolios. In doing so, we summarize the general arbitrage-free valuation framework for counterparty risk adjustments in presence of bilateral default risk, as developed more in detail in Brigo and Capponi (2008), including the default of the investor. We illustrate the symmetry in the valuation and show that the adjustment involves a long position in a put option plus a short position in a call option, both with zero strike and written on the residual net present value of the contract at the relevant default times. We allow for correlation between the default times of the investor and counterparty, and for correlation of each with the underlying risk factor, namely interest rates. We also analyze the often neglected impact of credit spread volatility. We include Netting in our examples, although other agreements such as Margining and Collateral are left for future work.