Modeling CVA for interest rate swaps in a CIR-framework

Abstract

Knowing the true Counterparty Credit Risk (CCR) and accurately account for it, is vital in maintaining a stable financial system. The Basel committee noted that during the financial crisis of 2008-2009, about 70% of losses related to CCR actually came from volatility in the Credit Value Adjustment (CVA) instead of actual defaults. This thesis is examining the properties of CVA, how to measure CCR and why it is important to be able to accurately model it. The model risk for CVA is investigated for an interest rate swap contract in a CIR-framework; the sensitivity of the CVA with respect to the underlying parameters in the given setting is studied. The modeling of the CVA is shown to come with great uncertainties to many of the included terms. It is shown that the final CVA value is sensitive to changes in the underlying parameters describing the interest rate as well as to variations in the other terms included in the CVA model.