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CVA with wrong-way risk and correlation between defaults: An application to an interest rate swap

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This paper presents a counterparty credit risk adjustment model to value overthe-counter financial derivatives. To do so, a bilateral credit valuation adjustment with  wrong-way risk (WWR) and dependency between the defaults of both contract parties is  developed in line with the Hull-White model (2012), which calculates default probabilities using a hazard rate modelled as an exponential function dependent on the value of  the derivative. The model proposed incorporates a modified hazard rate for each entity,  which includes the company’s own exposure to credit risk attributable to the other entity’s default. By so doing, a correlation between the respective defaults of the entities  party to the financial derivative is added. The model developed is also applied to obtain  the fair value of an interest rate swap and the results obtained, using Monte Carlo simulation, demonstrate that the value of this swap adjusted to the credit risk falls when  the dependency between the entities’ defaults is considered.

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Revista Cuadernos de Economía, 2023, vol. 1, num.3, p. 197-208

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Articles publicats en revistes (Matemàtica Econòmica, Financera i Actuarial)

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CVA with wrong-way risk and correlation between defaults: An application to an interest rate swap