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    Extending the Merton model with applications to credit value adjustment

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    Publication date
    2023
    End of Embargo
    2024-03-30
    Author
    Akyildirim, Erdinc
    Hekimoglu, A.A.
    Sensoy, A.
    Fabozzi, F.J.
    Keyword
    Finance
    Structural credit risk
    Merton model
    Variance-gamma process
    Credit value adjustment
    Rights
    © The Author(s), under exclusive licence to Springer Science+Business Media, LLC, part of Springer Nature 2023. This version of the article has been accepted for publication, after peer review (when applicable) and is subject to Springer Nature’s AM terms of use, but is not the Version of Record and does not reflect post-acceptance improvements, or any corrections. The Version of Record is available online at: https://doi.org/10.1007/s10479-023-05289-3.
    Peer-Reviewed
    Yes
    Open Access status
    embargoedAccess
    
    Metadata
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    Abstract
    Following the global financial crisis, the measurement of counterparty credit risk has become an essential part of the Basel III accord with credit value adjustment being one of the most prominent components of this concept. In this study, we extend the Merton structural credit risk model for counterparty credit risk calculation in the context of calculating the credit value adjustment mainly by estimating the probability of default. We improve the Merton model in a variance-convoluted-gamma environment to include default dependence between counterparties through a linear factor decomposition framework. This allows one to tackle dependence through a systematic common component. Our set-up allows for easier, faster and more accurate fitting for the credit spread. Results confirm that use of the variance-gamma-convolution clearly solves the vanishing credit spread problem for short time-to-maturity or low leverage cases compared to a Brownian motion environment and its modifications.
    URI
    http://hdl.handle.net/10454/19383
    Version
    Accepted manuscript
    Citation
    Akyildirim E, Hekimoglu AA, Sensoy A et al (2023) Extending the Merton model with applications to credit value adjustment. Annals of Operations Research. Accepted for Publication.
    Link to publisher’s version
    https://doi.org/10.1007/s10479-023-05289-3
    Type
    Article
    Notes
    The full-text of this article will be released for public view at the end of the publisher embargo on 30 March 2024.
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