Credit Risk Modeling and Implementation

Sammanfattning: The financial crisis and the bankruptcy of Lehman Brothers in 2008 lead to harder regulations for the banking industry which included larger capital reserves for the banks. One of the parts that contributed to this increased capital reserve was the the credit valuation adjustment capital charge which can be explained as the market value of the counterparty default risk. The purpose of the credit valuation adjustment capital charge is to capitalize the risk of future changes in the market value of the counterparty default risk. One financial contract that had a key role in the financial crisis was the credit default swap. A credit default swap involves three different parts, a contract seller, a contract buyer and a reference entity. The credit default swap can be seen as an insurance against a credit event, a default for example of the reference entity. This thesis focuses on the study and calculation of the credit valuation adjustment of credit default swaps. The credit valuation adjustment on a credit default swap can be implemented with two different assumptions. In the first case, the seller (buyer) of the contract is assumed to be default risk free and then only the buyer (seller) contributes to the default risk. In the second case, both the seller and the buyer of the contract is assumed to be default risky and therefore, both parts contributes to the default risk.