Lecture_7_CVA_201820180402201111

CVA
General Framework
CVA Features
CVA is a credit hybrid.
The positive part of the close-out amount introduces an element of optionality
in the payoff: i.e. a call option with zero strike on V(τ).
Optionality renders the payoff under counterparty risk model dependent,
even when the original payoff is model independent.
Example: Interest Rate Swap (IRS)
Without counterparty risk, the payoff is linear and model independent, requiring no
dynamical model for the term structure (no volatility and correlation). In the presence
ofcounterpartyrisk,thepayofftransformsintoastreamofswaptions, whosevaluation
requires an interest rate model.
Optionalityappliestothewhole netting setwithagivencounterparty,making
CVA valuation computationally intensive.
Paola Mosconi 20541 – Lecture 10-11 28 / 86