Valuation and Risk
Counterparty Credit Risk
Measuring counterparty credit risk, reducing it with netting and collateral, managing credit limits, and the regulatory treatment.
Introductory1 pagePractitioner6 pagesAdvanced1 page
1Exposure
- IntroductoryWhat Is Counterparty Credit Risk?When a counterparty fails, only the party for which the transaction has a positive value can lose that amount.
- PractitionerExposure Measures: CE, PFE, EE/EPE and EADCE is the positive part of today's market value, PFE a high percentile of the future distribution of exposure, EE its mean, and EPE the average of EE.
- PractitionerExposure Profiles by ProductThe shape of exposure comes from combining the widening range of market moves with the shrinking amount of remaining payments.
- AdvancedWrong-Way RiskIn a CVA valuation, estimating exposure and the counterparty's default separately understates the loss when the risk is wrong-way.
2Mitigation and Management
- PractitionerRisk Reduction through Netting and CollateralWith close-out netting, exposure is the positive part of the total market value of the trades, not the sum of each trade's positive market value.
- PractitionerCredit Limit ManagementA credit limit is a cap, set for each counterparty, on the amount that could be lost if that counterparty failed.
- PractitionerOverview of the Regulatory Treatment of Counterparty RiskThe regulation requires two kinds of capital, one against counterparty default and one against changes in the market value of CVA.
- PractitionerCounterparty Risk and XVACredit limits are measured by a high percentile of future exposure (PFE) and CVA by the average (EE), so the figures differ for the same trade.