A Model of Credit Value Adjustment
9/21/2013
Modeling Credit Value
Adjustment
FX Forwards and Currency Swaps
Alexi Carlos and Zedrick Torres
Introduction
This paper is concerned with the generalization of the Credit Value Adjustment (CVA) equation for FX
Forwards and Currency Swaps. In addition, a model for CVA using Visual Basic for Applications (VBA) in
Microsoft Excel will be presented.
Counterparty credit risk (CCR) is the risk that the counterparty to a financial contract will default prior to the expiration of the contract and will not make all the payments required by the contract (Zhu and
Pykhtin, 2007). The issue regarding CCR is something inevitable for over-the-counter (OTC) derivative transactions that is why it is very important to know how financial institutions value it. One of the best strategies in managing these exposures is through CVA. “Credit Valuation Adjustment” is an adjustment to the mid-market valuation of the portfolio of transactions with a counterparty which reflects the market value of the credit risk due to any failure to perform on contractual agreements with a counterparty. This adjustment may reflect the market value of the credit risk of the counterparty or the market value of the credit risk of both the bank and the counterparty (Central Bank of Cyprus).
© 2013 by Alexi Carlos and Zedrick Torres. All rights reserved
No part of this document may be reproduced or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of Alexi Carlos and Zedrick Torres.
Credit Value Adjustment in Theory
(
∑
LGD
)∫
(
{
( )
)
(
)
(
)} (
Probability of Default occurring in the period
)
Average exposure in the period
where
and is the recovery rate of default is the Credit Default Swap (CDS) spread of the counterparty at time t with respect to the credit rating o CDS spread is the percentage of the notional amount
Modeling Credit Value
Adjustment
FX Forwards and Currency Swaps
Alexi Carlos and Zedrick Torres
Introduction
This paper is concerned with the generalization of the Credit Value Adjustment (CVA) equation for FX
Forwards and Currency Swaps. In addition, a model for CVA using Visual Basic for Applications (VBA) in
Microsoft Excel will be presented.
Counterparty credit risk (CCR) is the risk that the counterparty to a financial contract will default prior to the expiration of the contract and will not make all the payments required by the contract (Zhu and
Pykhtin, 2007). The issue regarding CCR is something inevitable for over-the-counter (OTC) derivative transactions that is why it is very important to know how financial institutions value it. One of the best strategies in managing these exposures is through CVA. “Credit Valuation Adjustment” is an adjustment to the mid-market valuation of the portfolio of transactions with a counterparty which reflects the market value of the credit risk due to any failure to perform on contractual agreements with a counterparty. This adjustment may reflect the market value of the credit risk of the counterparty or the market value of the credit risk of both the bank and the counterparty (Central Bank of Cyprus).
© 2013 by Alexi Carlos and Zedrick Torres. All rights reserved
No part of this document may be reproduced or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of Alexi Carlos and Zedrick Torres.
Credit Value Adjustment in Theory
(
∑
LGD
)∫
(
{
( )
)
(
)
(
)} (
Probability of Default occurring in the period
)
Average exposure in the period
where
and is the recovery rate of default is the Credit Default Swap (CDS) spread of the counterparty at time t with respect to the credit rating o CDS spread is the percentage of the notional amount