Pricing and Mitigation of Counterparty Credit Exposures
Handbook of Systemic Risk, edited by J.-P. Fouque and J.Langsam. Cambridge University Press, 2012
21 Pages Posted: 12 Feb 2013
Date Written: January 31, 2013
We analyze the market price of counterparty risk and develop an arbitrage-free pricing valuation framework, inclusive of collateral mitigation. We show that the adjustment is given by the sum of option payoff terms, depending on the netted exposure, i.e. the difference between the on-default exposure and the pre-default collateral account. We specialize our analysis to Interest Rates Swaps (IRS) and Credit Default Swaps (CDS) as underlying portfolio, and perform a numerical study to illustrate the impact of default correlation, collateral margining frequency, and collateral re-hypothecation on the resulting adjustment. We also discuss problems of current research interest in the counterparty risk community.
Keywords: counterparty risk, systemic risk, default contagion, credit valuation adjustment
JEL Classification: C15, C63, C65, G12, G13
Suggested Citation: Suggested Citation