Counterparty Risk: A Review

Posted: 25 Nov 2014

See all articles by Stuart M. Turnbull

Stuart M. Turnbull

University of Houston - C.T. Bauer College of Business

Date Written: December 2014

Abstract

This review provides formal definitions of the terms credit value adjustment (CVA) and debt value adjustment (DVA). Estimating these quantities requires modeling the probabilities of default and the loss given default, recognizing the dependence structure among all these inputs. In practice, marginal distributions are used and a copula function assumed. Although it has long been known that different copula functions can produce very different price estimates, keeping marginal distributions constant, there is little empirical evidence about the appropriate form of function to use for modeling default dependence. This review discusses the use of collateral for risk mitigation and its effects on CVA. Regulators have argued that standardized contracts should be cleared through central counterparties (CCPs). However, there are arguments against CCPs.

Suggested Citation

Turnbull, Stuart M., Counterparty Risk: A Review (December 2014). Annual Review of Financial Economics, Vol. 6, pp. 241-258, 2014, Available at SSRN: https://ssrn.com/abstract=2530475 or http://dx.doi.org/10.1146/annurev-financial-110613-034515

Stuart M. Turnbull (Contact Author)

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

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