Acta Univ. Agric. Silvic. Mendelianae Brun. 2017, 65(3), 1015-1022 | DOI: 10.11118/actaun201765031015

Modelling Counterparty Credit Risk in Czech Interest Rate Swaps

Lenka Křivánková¹, Silvie Zlatošová²

¹ Department of Mathematics and Statistics, the Faculty of Science, Masaryk University, Žerotínovo náměstí 617/9, 601 77 Brno, Czech Republic

² Department of Finance, the Faculty of Economics and Administration, Masaryk University, Žerotínovo náměstí 617/9, 601 77 Brno, Czech Republic

According to the Basel Committee's estimate, three quarters of counterparty credit risk losses during the financial crisis in 2008 originate from credit valuation adjustment's losses and not from actual defaults. Therefore, from 2015, the Third Basel Accord (EU, 2013a) and (EU, 2013b) instructed banks to calculate the capital requirement for the risk of credit valuation adjustment (CVA). Banks are trying to model CVA to hold the prescribed standards and also reach the lowest possible impact on their profit. In this paper, we try to model CVA using methods that are in compliance with the prescribed standards and also achieve the smallest possible impact on the bank's earnings. To do so, a data set of interest rate swaps from 2015 is used. The interest rate term structure is simulated using the Hull-White one-factor model and Monte Carlo methods. Then, the probability of default for each counterparty is constructed. A safe level of CVA is reached in spite of the calculated the CVA achieving a lower level than CVA previously used by the bank. This allows a reduction of capital requirements for banks.

Keywords: counterparty credit risk, credit valuation adjustment, probability of default, interest rate swaps, yield curve, Hull-White model, Monte Carlo simulations, credit exposure

Prepublished online: July 3, 2017; Published: May 1, 2017  Show citation