ARBITRAGE-FREE VALUATION OF BILATERAL COUNTERPARTY RISK FOR INTEREST-RATE PRODUCTS: IMPACT OF VOLATILITIES AND CORRELATIONS

@inproceedings{Brigo2011ARBITRAGEFREEVO,
  title={ARBITRAGE-FREE VALUATION OF BILATERAL COUNTERPARTY RISK FOR INTEREST-RATE PRODUCTS: IMPACT OF VOLATILITIES AND CORRELATIONS},
  author={Damiano Brigo and Andrea Pallavicini and Vasileios Papatheodorou},
  year={2011}
}
The purpose of this paper is introducing rigorous methods and formulas for bilateral counterparty risk credit valuation adjustment (CVA) on interest-rate portfolios. In doing so, we summarize the general arbitrage-free valuation framework for counterparty risk adjustments in presence of bilateral default risk, including the default of the investor. We illustrate the symmetry in the valuation and show that the adjustment involves a long position in a put option plus a short position in a call… CONTINUE READING

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