A Sensitivity Based Approach for CVA Computation

Since the sub-prime crisis, counterparty credit risk and Wrong Way Risk are a crucial issue in connection with valuation and risk management of credit derivatives. For portfolios comprising other than simple vanilla products, calculating CVA could be a rather daunting task. In this work, we present a comprehensive approach to model CVA and Wrong Way Risk for equity portfolios. This approach is based on a first order approximation of exposures that allows us to derive closed-form formulas for CVA. Wrong Way risk is modeled through a Gaussian copula that connects default of the counterparty to the underlying portfolio.We test our model on two portfolios in two different credit risk scenarios and analyze the results obtained. In particular, we show how we retrieve the theoretical CVA in a computationally appealing manner. Some interesting properties of the Gaussian Copula related to Wrong Way Risk modeling are also discussed in the paper.