Counterparty risk and CCDSs under correlation

Counterparty risk under correlation is relatively unexplored in the financial literature. Here, Damiano Brigo and Andrea Pallavicini extend previous analysis beyond simple swap portfolios. A stochastic intensity jump diffusion model is adopted for the default event, and correlation between interest rates and credit shows a relevant and structured impact on the counterparty risk adjustment, naturally linked to contingent credit default swaps

In this article, we consider counterparty risk for interest rate payouts in the presence of correlation between credit and interest rates. In particular, we analyse counterparty risk (or default risk) interest rate swaps (IRSs) in detail, continuing the work of Sorensen & Bollier (1994), Brigo & Masetti (2006), where no correlation is taken into account, and Brigo & Pallavicini (2007), where the intensity process is considered to be a purely diffusive process.

We also analyse more exotic payouts

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