Chapter 8



Credit risk emerged as a significant risk management issue in the 1990s. In increasingly competitive markets, banks and securities houses are taking on more forms of credit risk. The following are instances:

  • credit spreads tightened in the late 1990s and the early part of 2000 to the point where blue chip companies – such as BT or Shell – benefitted from syndicated loans for as little as 10–12 basis points over the London Interbank Offered Rate (Libor); banks are turning to lower rated firms to maintain margin;
  • growth in complex financial instruments that are more chal lenging to manage than traditional instruments, such as credit derivatives;
  • investors are finding fewer opportunities in interest rate and currency markets and moving towards yield enhancement through extending and trading credit; for example, after EMU, participating government bond markets become credit markets;
  • high yield (junk) and emerging market sectors have been expand ing rapidly.

The growth in credit exposures and rise of complex instruments have led to a need for more sophisticated risk management techniques.


There are two main types of credit risk:

  • credit spread risk;
  • credit default risk.

Credit spread risk

Credit spread is the excess premium required by the market for taking on a certain assumed credit exposure. Credit spread risk ...

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