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CVA and Vulnerable Options in Stochastic Volatility Models
- Publication Year :
- 2021
-
Abstract
- This work aims to provide an efficient method to evaluate the Credit Value Adjustment (CVA) for a vulnerable European option, which is an option subject to some default event concerning the issuer solvability. Financial options traded in OTC markets are of this type. In particular, we compute the CVA in some popular stochastic volatility models such as SABR, Hull et al., which have proven to fit quite well market derivatives prices, admitting correlation with the default event. This choice covers the relevant case of Wrong Way Risk (WWR) when a credit deterioration determines an increase in the claim value. Contrary to the structural modeling adopted in [G. Wang, X. Wang & K. Zhu (2017) Pricing vulnerable options with stochastic volatility, Physica A 485, 91–103; C. Ma, S. Yue & Y. Ma (2020) Pricing vulnerable options with Stochastic volatility and Stochastic interest rate, Computational Economics 56, 391–429], we use the reduced-form intensity-based approach to provide an explicit representation formula for the vulnerable option price and related CVA. Later, we specialize the evaluation formula and construct its approximation for the three models mentioned above. Assuming a CIR model for the default intensity process, we run a numerical study to test our approximation, comparing it with Monte Carlo simulations. The results show that for moderate values of the correlation and maturities not exceeding one year, the approximation is very satisfactory as of accuracy and computational time.
- Subjects :
- Computer science
Event (relativity)
Monte Carlo method
vulnerable options
Computational Finance (q-fin.CP)
SABR volatility model
FOS: Economics and business
Stochastic volatility model
Quantitative Finance - Computational Finance
Credit value adjustment
intensity approach
Econometrics
Economics
Representation (mathematics)
Event (probability theory)
Actuarial science
Stochastic volatility
Settore SECS-S/06
Work (electrical)
Issuer
Pricing of Securities (q-fin.PR)
Credit valuation adjustment
General Economics, Econometrics and Finance
Quantitative Finance - Pricing of Securities
Finance
Subjects
Details
- Language :
- English
- Database :
- OpenAIRE
- Accession number :
- edsair.doi.dedup.....2198db52d5c171c77559ed16a0592b8e