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The credit risk components of a swap portfolio
Author(s) -
Hübner Georges
Publication year - 2004
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.10113
Subject(s) - netting , swap (finance) , portfolio , credit risk , credit default swap index , credit default swap , economics , credit valuation adjustment , variance swap , credit derivative , econometrics , financial economics , libor , business , model risk , actuarial science , risk management , monetary economics , finance , volatility swap , credit reference , volatility (finance) , interest rate , implied volatility
Thanks to the recent development of analytical pricing models for swaps with bilateral credit risk, acomprehensive analysis of the dimensions of default risk has become possible. Using the model developed byHübner (2001) for IRS and CS, this article investigates the impact ofstructural and temporary credit risk changes on swap prices. It emphasizes that large variations in swap valuesand sensitivities may exist depending on the sources of credit risk differences between the counterparties. Thisphenomenon is stronger for CS because of the exchange of principal and an additional correlation risk thatexhibits a nonnegligible impact on the contract value. The influence of a netting master agreement also can beanalyzed for a wide range of initial contract values and netted notionals. The results confirm the hedgingproperties put forward by Duffie and Huang (1996) as a special case, butclearly show that they cannot be generalized to any netting pattern. Prevailing market conditions are shown toplay a central role in the effectiveness of netting as a hedging device. © 2004 Wiley Periodicals, Inc. JrlFut Mark 24:93–115, 2004