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Interest Rate Swap Credit Value Adjustment, Jakub Černý, Jiří Witzany, 2013

Interest Rate Swap Credit Value Adjustment, Jakub Černý, Jiří Witzany, 2013

counterparty credit risk, credit value adjustment, interest rate swap price, risky swaption price, semi-analytical formula, wrong-way risk

The credit value 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 incorporating the wrong-way risk, i.e. the negative dependence between the underlying asset and the default time. A semi-analytical CVA formula simplifying the interest rate swap (IRS) valuation with counterparty credit risk (CCR) 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 by the swaption price. 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 results of a complex simulation study.