Calibration of a first passage model for CVA applications

Regulatory change, driven in part by the recent credit crisis, has created demand for banks to undertake a highly intensive risk calculation known as Credit Valuation Adjustment (CVA). CVA is essentially the price of an insurance contract covering the bank’s losses in the event that one of its trading counterparties defaults. QuIC, the sponsor of the proposed research project, is in the business of selling similar types of high-volume calculations to large investment banks. While QuIC has sold systems based on a somewhat simplified approach to CVA, it has also developed “on paper” a more comprehensive model of counterparty default that is still easily calibrated to various market observables. A key aspect of the model is that it accounts for correlation between the credit worthiness of its trading counterparties and market risk factors, such as interest and foreign exchange rates. This correlation plays a crucial role in a CVA calculation. The model also accounts for variations in the credit rating of the bank’s trading counterparties, which impacts CVA through the amount of collateral posted by the counterparty. The project will involve further development of this model and thorough testing vs. market data provided by Markit, QuIC’s new parent organization. The project will provide the intern with valuable exposure to practical software and business development issues. Likewise, if meaningful benefits can be demonstrated as part of this project, QuIC expects to be able to sell products based on it.

Faculty Supervisor:

Dr. Andrey Pavlov

Student:

Helen Yin

Partner:

QUIC Financial Technologies

Discipline:

Business

Sector:

Finance, insurance and business

University:

Simon Fraser University