Swap's fair value: CVA and DVA. A binomial approximation
DOI:
https://doi.org/10.32826/cude.v42i122.202Keywords:
Credit risk; fair value; swap; binomial; default probability.Abstract
The IFRS 13 is in force, in Spain, since January 1st, 2013. According to this standard, to obtain fair value of financial derivatives, adjustments for credit risk must be made. From an accounting point of view, credit risk adjustments are necessary for financial institutions and for all those entities that apply PGC 1514/2007.
This paper obtains the fair value of a generic interest rate swap. This fair value is its free risk value less CVA, or negative adjustment by the counterparty’s risk of default, and plus DVA, which is the provision or positive adjustment for its own risk of default.
To calculate CVA/DVA is necessary to know the expected exposure of the swap, which is obtained from a binomial model of forward interest rates. Also, it’s necessary to determinate default probabilities, which are derived from credit spreads of corporate bonds.
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