Restructuring Counterparty Credit Risk

27 Pages Posted: 7 Dec 2011 Last revised: 24 Jun 2012

See all articles by Claudio Albanese

Claudio Albanese

Global Valuation; CASS School of Business

Damiano Brigo

Imperial College London - Department of Mathematics

Frank Oertel

The London School of Economics and Political Science (LSE)

Multiple version iconThere are 2 versions of this paper

Date Written: November 1, 2011

Abstract

We introduce an innovative theoretical framework for the valuation and replication of derivative transactions between defaultable entities based on the principle of arbitrage freedom. Our framework extends the traditional formulations based on Credit and Debit Valuation Adjustments (CVA and DVA).

Depending on how the default contingency is accounted for, we list a total of ten different structuring styles. These include bi-partite structures between a bank and a counterparty, tri-partite structures with one margin lender in addition, quadri-partite structures with two margin lenders and, most importantly, configurations where all derivative transactions are cleared through a Central Counterparty Clearing House (CCP).

We compare the various structuring styles under a number of criteria including consistency from an accounting standpoint, counterparty risk hedgeability, numerical complexity, transaction portability upon default, induced behavior and macro-economic impact of the implied wealth allocation.

Suggested Citation

Albanese, Claudio and Brigo, Damiano and Oertel, Frank, Restructuring Counterparty Credit Risk (November 1, 2011). Available at SSRN: https://ssrn.com/abstract=1969344 or http://dx.doi.org/10.2139/ssrn.1969344

Claudio Albanese (Contact Author)

Global Valuation ( email )

9 Devonshire Sq.
London, London EC2M 4YF
United Kingdom

CASS School of Business ( email )

106 Bunhill Row
London, England EC1Y 8TZ
United Kingdom

Damiano Brigo

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www.imperial.ac.uk/people/damiano.brigo

Frank Oertel

The London School of Economics and Political Science (LSE) ( email )

London
United Kingdom

HOME PAGE: http://www.frank-oertel-math.de

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