Hedging Error in CVA : Impact of inconsistency between simulation and pricing models

Abstract: The aim of this thesis is to investigate thehedging error in Credit Value Adjustment (CVA) produced by using a model forthe simulation of the risk factors different from the one used in the pricingof the derivative contract. The hypothesis is that this inconsistency betweensimulation and pricing models affects the CVA leading to an error in thehedging of credit counterparty risk. When computing the CVA, market factors aresimulated forward in time and the portfolio is priced in each scenario toobtain the Expected Positive Exposure (EPE). To hedge the market risk of CVA weuse a dynamic Delta-hedging strategy. We investigate the hedging error for adefault free portfolio and for its CVA and how it is affected by the mismatchbetween the models.