In this paper we examine the problem of partially hedging a given credit risk exposure. We derive hedges which satisfy certain optimality criteria: For a given investment into the hedge they minimize the remaining risk, or vice versa. This is motivated by the fact that it is a core business of...

Research papers in empirical finance and financial econometrics are among the most widely cited, downloaded and viewed articles in the discipline of Finance. The special issue presents several papers by leading scholars in the field on “Recent Developments in Financial Economics and...

The topics of Economic Capital modelling, reverse stress testing and credit limits are inextricably intertwined as they all focus on exceptional loss events. In this paper, we use the KVA framework in to frame these three topics within a single unified approach. We propose setting credit limits...

The two main issues for managing wrong way risk (WWR) for the credit valuation adjustment (CVA, i.e. WW-CVA) are calibration and hedging. Hence we start from a novel model-free worst-case approach based on static hedging of counterparty exposure with liquid options. We say "start from" because...

Based on a reduced-form model of credit risk, we explore mispricing in the CDS spreads of North American companies and its economic content. Specifically, we develop a trading strategy using the model to trade out of sample market-neutral portfolios across the term structure of CDS contracts....

We apply Geometric Arbitrage Theory to obtain results in mathematical finance for credit markets, which do not need stochastic differential geometry in their formulation. We obtain closed form equations involving default intensities and loss given defaults characterizing the...

This paper first designs an efficient procedure to value Credit Default Swap Index tranches using an intensity-based model. The tranche spreads are effectively explained by a three-factor version of this model, both before and during the financial crisis of 2008. We then construct tradable...

Basel III introduces new capital charges for CVA. These charges, and the Basel 2.5 default capital charge can be mitigated by CDS. Therefore, to price in the capital relief that CDS contracts provide, we introduce a CDS pricing model with three legs: premium; default protection; and capital...

We document a strong positive cross-sectional relation between corporate bond yield spreads and bond return volatilities. As corporate bond prices are generally attributable to both credit risk and illiquidity as discussed in Huang and Huang (2012), we apply a decomposition methodology to...