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A Copula Approach to CVA Modeling, Jakub Černý, Jiří Witzany, 2015

A Copula Approach to CVA Modeling, Jakub Černý, Jiří Witzany, 2015

Copulas, counterparty credit risk, Credit Valuation Adjustment, Interest Rate Swaps, wrong-way risk

We consider counterparty credit risk in the interest rate swap (IRS) contracts in the presence of an adverse dependence between the default time and interest rates, so-called wrong-way risk. The IRS credit valuation adjustment (CVA) semi-analytical formula based on Gaussian copula assumption, presented in Černý and Witzany [2014], is further replaced by Fréchet copula (for extreme dependence) mainly based on the work of Cherubini [2013], called modified approach. The result of all three CVA calculation approaches are compared in a numerical study where we find that our semi-analytical formulas (the Gaussian copula and modified approach) provide more accurate information on IRS CVA price.