Credit Value Adjustment with Market-implied Recovery

Credit Value Adjustment with Market-implied Recovery

We present a model for CVA calculation in which the recovery rate is inferred from the term structure of CDS spreads. The negative relation between recovery rates and default probabilities induces a substantial underestimation of the CVA when constant recovery is assumed. That underestimation prevai...

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Bibliographic Details
Published in:Journal of financial services research Vol. 56; no. 2; pp. 145 - 166
Main Authors: François, Pascal, Jiang, Weiyu
Format: Journal Article
Language:English
Published: New York Springer US 01-10-2019
Springer Nature B.V
Subjects:
Credit
Credit default swaps
Credit risk
Derivatives
Economics and Finance
Finance
Financial Services
Macroeconomics/Monetary Economics//Financial Economics
Recovery
Implied recovery
OTC derivatives
Credit risk
CVA
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Summary:We present a model for CVA calculation in which the recovery rate is inferred from the term structure of CDS spreads. The negative relation between recovery rates and default probabilities induces a substantial underestimation of the CVA when constant recovery is assumed. That underestimation prevails for both unilateral and bilateral CVA as well as for the CVA capital charge. The underestimation gets more severe as the horizon of the position increases. Our CVA model with market-implied recovery also offers a way to capture correlation effects between the level of exposure and counterparty risk.
ISSN:0920-8550
1573-0735
DOI:10.1007/s10693-018-0298-5