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An Accurate Solution for Credit Valuation Adjustment (CVA) and Wrong Way Risk

Xiao, Tim · 2015
PhilArchive · Papers · 2015
Open Source ↗
philosophy
This paper presents a Least Square Monte Carlo approach for accurately calculating credit value adjustment (CVA). In contrast to previous studies, the model relies on the probability distribution of a default time/jump rather than the default time itself, as the default time is usually inaccessible. As such, the model can achieve a high order of accuracy with a relatively easy implementation. We find that the valuation of a defaultable derivative is normally determined via backward induction when their payoffs could be positive or negative. Moreover, the model can naturally capture wrong or right way risk.
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