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arXiv · 2003.03403

Model independent WWR for regulatory CVA and for accounting CVA and FVA

Chris Kenyon·Mourad Berrahoui·Benjamin Poncet
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Abstract

General wrong way risk (WWR) estimation is necessary for regulatory CVA capital and useful for pricing CVA and FVA. We introduce a model independent method for calculating WWR and update the definition of WWR to deal with the lack of replication instruments (calibration data) transparently. This model independent approach is extremely simple: we just re-write the CVA and FVA integral expressions in terms of their components and then calibrate these components. This provides transparency between component calibration and CVA/FVA effect because there is no model interpretation in between. Including funding in WWR means that there are now two WWR terms rather than the usual one. Using a regulatory inspired calibration from MAR50 we investigate WWR effects for vanilla interest rate swaps and show that the WWR effects for FVA are significantly more material than for CVA. This model independent approach can also be used to compare any WWR model by simply calibrating to it for a portfolio and counterparty, to demonstrate the effects of the model under investigation in terms of components of CVA/FVA calculations.

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Chris Kenyon, Mourad Berrahoui, Benjamin Poncet. 2020-03-06. Model independent WWR for regulatory CVA and for accounting CVA and FVA. https://arxiv.org/abs/2003.03403

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