Lecture_7_CVA_201820180402201111

CVA Calculation
Wrong Way Risk
Basel II
Basel II deals with wrong-way risk using the so-called “alpha”multiplier to
increase the exposure, in the version of the model in which exposure and
counterparty creditworthiness are assumed to be independent.
The effect is to increase CVA by the alpha multiplier.
The Basel II rules set alpha equal to 1.4 or allows banks to use their own models,
with a floor for alpha of 1.2, i.e.
if a bank uses its own model, at minimum, the CVA has to be 20% higher than
that given by the model where default and exposure are independent
if a bank does not have its own model for wrong way risk it has to be 40%
higher
Estimates of alpha reported by banks range from 1.07 to 1.10.
Paola Mosconi 20541 – Lecture 10-11 42 / 86