Alper Ali Hekimoğlu, Ph.D.
Department of Financial Mathematics
December 2018

Supervisor: Ömür Uğur (Institute of Applied Mathematics, Middle East Technical University, Ankara)
Co-Supervisor: Sevtap Kestel (Institute of Applied Mathematics, Middle East Technical University, Ankara)

Abstract

After 2008-2009 crisis, measurement of Counterparty Credit risk has become an essential part of Basel-III regulations. The measurement involves a complex calculation, simulation and scenario generation process which involve a heavy computational cost. Moreover, the counterparty default calculation is an important part depending on scenario generation and state of the economy, state of the counterparty, liquidity as well as the bank itself.

In this thesis we develop flexible structural credit risk models and an efficient simulation framework for Counterparty Credit Risk calculations. The credit risk models are of Merton type, Black-Cox Barrier type and Stochastic Barrier type in Variance Gamma environment. We proceeded by modifying stochastic volatility models to be used for credit risk and default dependence. Moreover, we derive a liquidity adjusted option price for stochastic volatility models to measure indirect effect of liquidity on credit spreads. The models studied were all developed to include default dependence between counterparties using an affine factor framework.

Keywords: Counterparty Credit Risk, Efficient Simulation, Structural Credit Risk, Variance Gamma, Stochastic Volatility, Liquidity adjustment