Pricing Counterparty by Edu Pristine

Author of lecture Pricing Counterparty

Edu Pristine

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... cost may increase due to downgrades. This is a function of default probability of counterparty, loss given default after considering collateralization impact and credit exposure after considering netting effects. Pricing is essential since a Bank/FI may have to allocate ...

... of a standalone value it can be expressed as a running spread. CAV as a spread : ...

... Collateralization reduces the CVA since it reduces the counterparty's expected exposure (EE) but does not alter its probability of default. However, incorporating Minimum Transfer, Rounding and Threshold amounts will increase the CVA since they increase the exposure linearly. ... 

... after considering the effects of netting. Observations for Incremental CVA: CVA with netting will never be higher than CVA without netting since netting cannot increase exposure. ...

... understand which trades have the greatest impact on a counterparty's CVA. Marginal CVA can be less than or equal to the standalone CVA numbers. ...

... trades Incremental & Marginal CVA's for a netting set of IRS and CCS (bps). Instrument Standalone Incremental Marginal 5 year ... 

... approximated using a European style payoff. -Knock in or Knock out features assumed to be triggered with 100% probability. Path dependency also results in problems since the entire path expected exposures have to be ...

... was calculated for counterparty risk that favors a stronger counterparty (Banks/FI). Bilateral CVA assumes that both counterparties may default and is based on the original CVA formula and assumes that no wrong way risk is there. ...

... If CVA is negative then netting may not be beneficial since without netting the institution may cherry pick contracts with positive MtM for settlement and discard negative MtM contracts ...

... if the counterparty is more risky than the institution and negative if vice versa. BCVA also depends on the symmetry of future MtM i.e. magnitude of EPE compared with ENE. Bilateral CVA helps both the counterparties to agree on a price. ...

... Funding Arguments: Using BCVA a firm can book profit on its own default which incentivizes the institutions to book gains by: -Filing for or going close to bankruptcy. -Undervaluing its own debt by purchasing it for cash but is unlikely for a bankrupt company. ... 

... - away features can be used in case of negative MtM which will allow the CVA owing counterparty to unwind the trade ...