Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets, 2nd Edition

9.8 Summary

In this chapter we have described the quantification of credit exposure by various methods, ranging from simple approximations to a more general simulation approach. We have outlined the method for simulating exposure for different asset classes. Examples have been given to show the impact of netting on exposure and we have discussed the allocation of exposure either incrementally or marginally. We have also discussed the quantification of exposure in the presence of collateral, showing that the presence of a collateral agreement changes the nature of future exposure quite significantly but does not always reduce the risk as much as may be imagined.

So far, this book has been concerned mainly with credit exposure. Whilst this is a critical component of counterparty risk, it is not the only component. Assessing the potential magnitude of a credit exposure is a useful step but is meaningless without an associated quantification of the probability that a counterparty will default. In Chapter 10, we will turn our attention to credit risk and default probability to define counterparty risk more fully as credit exposure coupled to the likelihood of an actual default event.

Notes

1. We note that these analytical formulas are generally concerned with calculating risk-neutral exposures using underlyings such as traded swaption prices. Such approaches can also be used for real-world calculations (as is usual for PFE) by simply using alternative data sources.

2. Correlation is ...