Journal of Credit Risk

A copula approach to credit valuation adjustment for swaps under wrong-way risk

Jakub Černý and Jiří Witzany

This paper presents:

  • A new interest rate swap credit valuation adjustment analytical formula.
  • Rigorous derivation of the formula including wrong-way risk using the Fréchet bounds.
  • Comparison of the derived formula with other analytical approaches.

This paper deals with the credit valuation adjustment (CVA) of interest rate swap (IRS) contracts in the presence of an adverse dependence between the default time and interest rates: so-called wrong-way risk (WWR). It compares the upper Fréchet bound approach introduced in a 2013 paper by Umberto Cherubini with a new semi- analytical IRS–CVA formula that we are proposing as a modification of Cherubini’s approach. The approaches are compared via a numerical study, in which we find that our semianalytical formula (the modified approach) provides more precise IRS–CVA valuation results.

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