Post by Sapphire Capital on Aug 14, 2008 21:33:47 GMT 4
Counterparty Risk Valuation for Energy-Commodities Swaps: Impact of Volatilities and Correlation
Damiano Brigo
Fitch Solutions; Imperial College - Department of Mathematics
Kyriakos Chourdakis
FitchSolutions; CCFEA
Imane Bakkar
Formerly Fitch Solutions
June 24, 2008
Abstract:
It is commonly accepted that Commodities futures and forward prices, in principle, agree under some simplifying assumptions. One of the most relevant assumptions is the absence of counterparty risk. Indeed, due to margining, futures have practically no counterparty risk. Forwards, instead, may bear the full risk of default for the counterparty when traded with brokers or outside clearing houses, or when embedded in other contracts such as swaps. In this paper we focus on energy commodities and on Oil in particular. We use a hybrid commodities-credit model to assess impact of counterparty risk in pricing formulas, both in the gross effect of default probabilities and on the subtler effects of credit spread volatility, commodities volatility and credit-commodities correlation. We illustrate our general approach with a case study based on an oil swap, showing that an accurate valuation of counterparty risk depends on volatilities and correlation and cannot be accounted for precisely through a pre-defined multiplier.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1150818_code268434.pdf?abstractid=1150818&mirid=1
Damiano Brigo
Fitch Solutions; Imperial College - Department of Mathematics
Kyriakos Chourdakis
FitchSolutions; CCFEA
Imane Bakkar
Formerly Fitch Solutions
June 24, 2008
Abstract:
It is commonly accepted that Commodities futures and forward prices, in principle, agree under some simplifying assumptions. One of the most relevant assumptions is the absence of counterparty risk. Indeed, due to margining, futures have practically no counterparty risk. Forwards, instead, may bear the full risk of default for the counterparty when traded with brokers or outside clearing houses, or when embedded in other contracts such as swaps. In this paper we focus on energy commodities and on Oil in particular. We use a hybrid commodities-credit model to assess impact of counterparty risk in pricing formulas, both in the gross effect of default probabilities and on the subtler effects of credit spread volatility, commodities volatility and credit-commodities correlation. We illustrate our general approach with a case study based on an oil swap, showing that an accurate valuation of counterparty risk depends on volatilities and correlation and cannot be accounted for precisely through a pre-defined multiplier.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1150818_code268434.pdf?abstractid=1150818&mirid=1