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Computing credit valuation adjustment for Bermudan options with wrong way risk

Journal Article (2018)
Author(s)

Q. Feng (Centrum Wiskunde & Informatica (CWI))

C.W. Oosterlee (Centrum Wiskunde & Informatica (CWI), TU Delft - Numerical Analysis)

Research Group
Numerical Analysis
Copyright
© 2018 Q. Feng, C.W. Oosterlee
DOI related publication
https://doi.org/10.1142/S021902491750056X
More Info
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Publication Year
2018
Language
English
Copyright
© 2018 Q. Feng, C.W. Oosterlee
Research Group
Numerical Analysis
Issue number
8
Volume number
20
Pages (from-to)
1-31
Reuse Rights

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Abstract

We study the impact of wrong way risk (WWR) on credit valuation adjustment (CVA) for Bermudan options. WWR is modeled by a dependency between the underlying asset and the intensity of the counterparty's default. Two WWR models are proposed, based on a deterministic function and a CIR-jump (CIRJ) model, respectively. We present a nonnested Monte Carlo approach for computing CVA-VaR and CVA-expected shortfall (ES) for Bermudan options. By varying correlation coefficients, we study the impact of credit quality and WWR on the optimal exercise boundaries and CVA values of Bermudan products. Stress testing is performed.