IDEAS home Printed from https://ideas.repec.org/a/wsi/ijtafx/v18y2015i03ns021902491550017x.html
   My bibliography  Save this article

Cva With Wrong Way Risk: Sensitivities, Volatility And Hedging

Author

Listed:
  • OMAR EL HAJJAJI

    (BMCE Capital, 9 Chemin Pierre de Ronsard, 92400 Courbevoie, France)

  • ALEXANDER SUBBOTIN

    (Nordea Bank, Christiansbro, Strandgade 3, DK-1401 Copenhagen K, Denmark)

Abstract

We propose a Credit Value Adjustment (CVA) model capturing the Wrong Way Risk (WWR) that is not product-specific and is suitable for large-scale computations. The model is based on a doubly stochastic default process with the default intensities proxied by credit spreads. For different exposure structures, we show how credit–market correlation affects the CVA level, its sensitivities to credit and market factors, its volatility and the quality of hedging. The WWR is most significant for exposures highly sensitive to the market volatility in a situation when credit spreads are at moderate levels but both the market factors and credit spreads are volatile. In such conditions, ignoring credit–market correlations results in important CVA mispricing. While the benefits from hedging are always magnified in the situation of the WWR, the right way exposure case is more delicate: only a well-designed mix of credit and market hedges can bring volatility down. Our results raise doubts on the Basel III policy of recognizing credit but not market hedges for computing the CVA volatility capital charge.

Suggested Citation

  • Omar El Hajjaji & Alexander Subbotin, 2015. "Cva With Wrong Way Risk: Sensitivities, Volatility And Hedging," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 18(03), pages 1-31.
    • Handle: RePEc:wsi:ijtafx:v:18:y:2015:i:03:n:s021902491550017x
    DOI: 10.1142/S021902491550017X
    as

    Download full text from publisher

    File URL: http://www.worldscientific.com/doi/abs/10.1142/S021902491550017X
    Download Restriction: Access to full text is restricted to subscribers
    File URL: https://libkey.io/10.1142/S021902491550017X?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Derek Singh & Shuzhong Zhang, 2019. "Distributionally Robust XVA via Wasserstein Distance Part 2: Wrong Way Funding Risk," Papers 1910.03993, arXiv.org.
    2. Derek Singh & Shuzhong Zhang, 2020. "Distributionally Robust XVA via Wasserstein Distance: Wrong Way Counterparty Credit and Funding Risk," Applied Economics and Finance, Redfame publishing, vol. 7(6), pages 70-100, December.
    3. Derek Singh & Shuzhong Zhang, 2019. "Distributionally Robust XVA via Wasserstein Distance: Wrong Way Counterparty Credit and Funding Risk," Papers 1910.01781, arXiv.org, revised May 2020.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wsi:ijtafx:v:18:y:2015:i:03:n:s021902491550017x. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Tai Tone Lim (email available below). General contact details of provider: http://www.worldscinet.com/ijtaf/ijtaf.shtml .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.