Measuring Counterparty Credit Exposure to a Margined Counterparty

18 Pages Posted: 5 Jan 2006

Date Written: November 2005

Abstract

Firms active in OTC derivative markets increasingly use margin agreements to reduce counterparty credit risk. Making several simplifying assumptions, I use both a quasi-analytic approach and a simulation approach to quantify how margining reduces counterparty credit exposure. Margining reduces counterparty credit exposure by over 80 percent, using baseline parameter assumptions. I show how expected positive exposure (EPE) depends on key terms of the margin agreement and the current mark-to-market value of the portfolio of contracts with the counterparty. I also discuss a possible shortcut that could be used by firms that can model EPE without margin but cannot achieve the higher level of sophistication needed to model EPE with margin.

Keywords: Counterparty risk, collateral, margin, derivatives

JEL Classification: G12

Suggested Citation

Gibson, Michael S., Measuring Counterparty Credit Exposure to a Margined Counterparty (November 2005). FEDs Working Paper No. 2005-50. Available at SSRN: https://ssrn.com/abstract=873867 or http://dx.doi.org/10.2139/ssrn.873867

Michael S. Gibson (Contact Author)

Federal Reserve Board ( email )

Washington, DC 20551
United States
1-202-452-2495 (Phone)

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