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Credit Valuation Adjustment in theory and practice
This thesis is intended to give an overview of credit valuation adjustment (CVA) and adjacent concepts. Firstly, the historical events that preceded the initiative to reform the Basel regulations and to introduce CVA as a core component of counterparty credit risk are illustrated. After some conceptual background material, a journey is taken through the regulatory aspects of CVA. The three most commonly used methods for calculating the regulatory CVA capital charge are explained in detail and potential challenges with the methods are addressed. Further, the document analyses in greater depth two of the methods; the internal model method (IMM) and the current exposure method (CEM). The differences between these two methods are explained mathematically and analysed. This comparison is supported by simulations of portfolios containing interest rate swap contracts with different time to maturity and of counterparties with varying credit ratings. One concluding observations is that credit valuation adjustment is a measure of central importance within counterparty credit risk. Further, it is shown that IMM has some important advantages over CEM, especially when it comes to model connection with reality. Finally, some possible future work to be done within the topic area is suggested.
, Dan Franzen, Otto Sjoholm (2014)
Bond Implied CDS Spread and CDS-Bond Basis
We derive a simple formula for calculating the CDS spread implied by the bond market price. Using no-arbitrage argument, the formula expresses the bond implied CDS spread as the sum of bond price, bond coupon and Libor zero curve weighted by risky annuities. We show that the bond implied CDS spread is consistent with the standard CDS pricing model if the survival probabilities and recovery are consistent with the bond price.
, Richard Zhou (2008)
Exploring the CDS-Bond Basis
Markets for credit default swaps (CDS) and bonds of the same reference entity and maturity are bound by no-arbitrage conditions. Indeed, using a large data set we show that CDS premia and par asset swap spreads are mostly cointegrated. Nonetheless, the average CDS-bond basis (i.e. the difference between both measures) is positive in the period 2004-2005. We detect fourteen different economic basis drivers, which make the basis firm-specific and time-dependent. Furthermore, we describe the basis smile, and illustrate that the average basis is the lowest for five year maturities of corporate credits denominated in euro.
, Jan De Wit (2006)
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