Credit Valuation Adjustment Wrong-Way Risk in a Gaussian Copula Model

16 Pages Posted: 23 Dec 2019

See all articles by Kelin Pan

Kelin Pan

Citi Internal Audit - Model Risk Management

Chandra Khandrika

Citi Internal Audit - Model Risk Management

Date Written: July 2019

Abstract

The credit valuation adjustment (CVA) is currently calculated in financial institutions to measure counterparty credit risk (CCR) on over-the-counter derivatives. A key factor in CVA is wrong-way risk (WWR): the correlation between counterparty exposures and credit qualities. In this paper, we present an analytical expression for CVA with WWR under the assumption of the lognormally distributed trade value. Using a Gaussian latent variable to drive market–credit correlation, the calculation of WWR is easily incorporated into the existing exposure simulation process in a CCR system. The proposed CVA with WWR model is used to find the CVA alpha that is a function of the market–credit correlation and the counterparty credit quality. The CVA alpha is used to study general WWR and specific WWR. The numerical results show that the entity’s rating downgrade has more of an impact on specific WWR than on general WWR.

Suggested Citation

Pan, Kelin and Khandrika, Chandra, Credit Valuation Adjustment Wrong-Way Risk in a Gaussian Copula Model (July 2019). Journal of Credit Risk, Vol. 15, No. 4, 2019, Available at SSRN: https://ssrn.com/abstract=3507990

Kelin Pan (Contact Author)

Citi Internal Audit - Model Risk Management ( email )

3800 Citibank Center
Tampa, FL 33610
United States

Chandra Khandrika

Citi Internal Audit - Model Risk Management ( email )

One Court Square
Long Island City, NY 11101
United States

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