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Credit Value Adjustment with Market-implied Recovery

  • Pascal FrançoisEmail author
  • Weiyu Jiang
Article
  • 96 Downloads

Abstract

We present a model for CVA calculation in which the recovery rate is inferred from the term structure of CDS spreads. The negative relation between recovery rates and default probabilities induces a substantial underestimation of the CVA when constant recovery is assumed. That underestimation prevails for both unilateral and bilateral CVA as well as for the CVA capital charge. The underestimation gets more severe as the horizon of the position increases. Our CVA model with market-implied recovery also offers a way to capture correlation effects between the level of exposure and counterparty risk.

Keywords

CVA Implied recovery Credit risk OTC derivatives 

Notes

Acknowledgments

We thank Aurore Burietz, Sanjiv Das, Jan Ericsson, Christophe Pérignon, Haluk Ünal (editor) and an anonymous referee for their feedback. The paper also benefited from helpful comments by seminar participants at Laval University and 2016 AFFI conference attendees. We are responsible for any inadequacies.

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Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2018

Authors and Affiliations

  1. 1.HEC MontrealMontrealCanada
  2. 2.McGill UniversityMontrealCanada

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