Publication detail

Interest Rate Swap Credit Valuation Adjustment

Author(s): RNDr. Jiří Witzany Ph.D., Jakub Černý
Type: IES Working Papers
Year: 2014
Number: 16
ISSN / ISBN:
Published in: IES Working Papers 16/2014
Publishing place: Prague
Keywords: Counterparty Credit Risk, Credit Valuation Adjustment, Wrong-way Risk, Risky Swaption Price, Semi-analytical Formula, Interest Rate Swap Price
JEL codes: C63, G12, G13, G32
Suggested Citation: Černý J., Witzany J. (2014). “Interest Rate Swap Credit Valuation Adjustment” IES Working Paper 16/2014. IES FSV. Charles University.
Abstract: The credit valuation adjustment (CVA) of OTC derivatives is an important part of
the Basel III credit risk capital requirements and current accounting rules. Its
calculation is not an easy task - not only it is necessary to model the future value of
the derivative, but also the probability of default of a counterparty. Another
complication arises in the calculation when the exposure to a counterparty is
adversely correlated with the credit quality of that counterparty, i.e. when it is
needed to incorporate the wrong-way risk. A semi-analytical CVA formula
simplifying the interest rate swap (IRS) valuation with the counterparty credit risk
including the wrong-way risk is derived and analyzed in the paper. The formula is
based on the fact that the CVA of an IRS can be expressed using swaption prices.
The link between the interest rates and the default time is represented by a
Gaussian copula with constant correlation coefficient. Finally, the results of the
semi-analytical approach are compared with the results of a complex simulation
study.
Downloadable: WP_2014_16_Cerny_Witzany

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