An introduction to rating triggers for collateral-inclusive XVA in an ICTMC framework
Abstract
In this paper, we model the rating process of an entity as a piecewise homogeneous continuous time Markov chain. We focus specifically on calibrating the model to both historical data (rating transition matrices) and market data (CDS quotes), relying on a simple change of measure to switch from the historical probability to the risk-neutral one. We overcome some of the imperfections of the data by proposing a novel calibration procedure, which leads to an improvement of the entire scheme. We apply our model to compute bilateral credit and debit valuation adjustments of a netting set under a CSA with thresholds depending on ratings of the two parties.
- Publication:
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arXiv e-prints
- Pub Date:
- July 2022
- DOI:
- 10.48550/arXiv.2207.03883
- arXiv:
- arXiv:2207.03883
- Bibcode:
- 2022arXiv220703883K
- Keywords:
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- Quantitative Finance - Risk Management;
- Quantitative Finance - Computational Finance