A Lévy HJM Multiple-Curve Model with Application to CVA Computation

Stéphane Crépey, Zorana Grbac, Nathalie Ngor, David Skovmand

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Abstract

We consider the problem of valuation of interest rate derivatives in the post-crisis set-up. We develop a multiple-curve model, set in the HJM framework and driven by a Lévy process. We proceed with joint calibration to OTM swaptions and co-terminal ATM swaptions of different tenors, the calibration to OTM swaptions guaranteeing that the model correctly captures volatility smile effects and the calibration to co-terminal ATM swaptions ensuring an appropriate term structure of the volatility in the model. To account for counterparty risk and funding issues, we use the calibrated multiple-curve model as an underlying model for CVA computation. We follow a reduced-form methodology through which the problem of pricing the counterparty risk and funding costs can be reduced to a pre-default Markovian BSDE, or an equivalent semi-linear PDE. As an illustration, we study the case of a basis swap and a related swaption, for which we compute the counterparty risk and funding adjustments
Original languageEnglish
JournalQuantitative Finance
Volume15
Issue number3
Pages (from-to)401-419
Number of pages19
ISSN1469-7688
DOIs
Publication statusPublished - 2015

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