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Counterparty Risk and the Impact of Collateralization in CDS Contracts

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  • Tomasz R. Bielecki
  • Igor Cialenco
  • Ismail Iyigunler

Abstract

We analyze the counterparty risk embedded in CDS contracts, in presence of a bilateral margin agreement. First, we investigate the pricing of collateralized counterparty risk and we derive the bilateral Credit Valuation Adjustment (CVA), unilateral Credit Valuation Adjustment (UCVA) and Debt Valuation Adjustment (DVA). We propose a model for the collateral by incorporating all related factors such as the thresholds, haircuts and margin period of risk. We derive the dynamics of the bilateral CVA in a general form with related jump martingales. We also introduce the Spread Value Adjustment (SVA) indicating the counterparty risk adjusted spread. Counterparty risky and the counterparty risk-free spread dynamics are derived and the dynamics of the SVA is found as a consequence. We finally employ a Markovian copula model for default intensities and illustrate our findings with numerical results.

Suggested Citation

  • Tomasz R. Bielecki & Igor Cialenco & Ismail Iyigunler, 2011. "Counterparty Risk and the Impact of Collateralization in CDS Contracts," Papers 1104.2625, arXiv.org, revised Aug 2011.
    • Handle: RePEc:arx:papers:1104.2625
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    Cited by:

    1. Azusa Takeyama & Nick Constantinou & Dmitri Vinogradov, 2012. "Credit Risk Contagion and the Global Financial Crisis," IMES Discussion Paper Series 12-E-15, Institute for Monetary and Economic Studies, Bank of Japan.
    2. Long Teng & Matthias Ehrhardt & Michael Günther, 2013. "Bilateral Counterparty Risk Valuation Of Cds Contracts With Simultaneous Defaults," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(07), pages 1-20.
    3. Jean-Paul Laurent & Philippe Amzelek & Joe Bonnaud, 2014. "An overview of the valuation of collateralized derivative contracts," Review of Derivatives Research, Springer, vol. 17(3), pages 261-286, October.
    4. Tomasz R. Bielecki & Igor Cialenco & Ismail Iyigunler, 2012. "Collateralized CVA Valuation with Rating Triggers and Credit Migrations," Papers 1205.6542, arXiv.org.
    5. Giovanni Mottola, 2014. "A stochastic switching control model arising in general OTC contracts with contingent CSA in presence of CVA, collateral and funding," Papers 1412.1469, arXiv.org.

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