Lecture_7_CVA_201820180402201111

CVA Calculation
Monte Carlo Valuation
Approximation 1: Models I
In order to simulate all the variables that affect the calculation of CVA, we
need to define their dynamics. We follow two criteria:
simplicity of the models
straightforward calibration of the models to liquid market instruments
Let Z(t) = {X(t),λ C ,λ I } be the set of all processes underlying the calculation
of CVA, where X denotes the risk drivers, λ C and λ I respectively the default
of the counterparty and the default of the investor 2 .
Each process, under the risk neutral measure Q, follows a dynamics
dZ i (t) = (...)dt +(...)dW i
and is correlated to the others through dW i (t)dW j (t) = ρ ij dt.
2 In the following, we will consider the investor default free λ I = 0, such that only the default
of the counterparty matters λ C ≡ λ.
Paola Mosconi 20541 – Lecture 10-11 46 / 86