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In Rememberance: World Trade Center (WTC)

Contagion Effects and Collateralized Credit Value Adjustments for Credit Default Swaps

by Rüdiger Frey of Vienna University of Business and Economics, and
Lars Rösler of Vienna University of Business and Economics

January 31, 2013

Abstract: The paper is concerned with counterparty credit risk management for credit default swaps in the presence of default contagion. In particular, we study the impact of default contagion on credit value adjustments such as the BCCVA (Bilateral Collateralized Credit Value Adjustment) of (Brigo et al. 2012) and on the performance of various collateralization strategies. We use the incomplete-information model of Frey and Schmidt(2012) as vehicle for our analysis. We find that taking contagion effects into account is important for the effectiveness of the strategy and we derive refined collateralization strategies to account for contagion effects.

Keywords: Counterparty credit risk, bilateral credit value adjustment, contagion, credit default swap, incomplete information, collateralization.

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