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

11.1 Introduction

In the last chapter, we considered the default probability of a single counterparty. The next component to consider is portfolio-level aspects, requiring consideration of the risk posed by two or more counterparties. We will first do this for two counterparties and discuss “double default risk”, which is an important consideration in assessing the hedging benefits that may be derived from credit derivatives. The concept of economic capital applied to credit portfolios has been much studied over the past two decades. We will consider how the uncertainty of exposure influences economic capital. This will be discussed in more detail in Chapter 17 with the Basel II requirements for counterparty risk.