Measuring Counterparty Credit Risk for Trading Products under Basel II

BASEL II HANDBOOK, Michael Ong, ed., RISK Books, 2006

22 Pages Posted: 1 Nov 2006 Last revised: 22 Jan 2016

See all articles by Michael Pykhtin

Michael Pykhtin

Board of Governors of the Federal Reserve System

Steven H. Zhu

Banc of America Merrill Lynch; Morgan Stanley

Date Written: September 18, 2006

Abstract

We described the treatment of counterparty credit risk of OTC derivatives under Basel II. According to this framework, minimum capital requirements for counterparty credit risk are to be calculated according to the corporate loan rules applied to the appropriate exposure at default (EAD) calculated at the netting set level. We present both Non-Internal and Internal Model Methods (IMM) of calculating this EAD. To obtain supervisory approval for the IMM, banks must be able to calculate expected exposure at the netting set level for a set of future dates. We also discussed a modeling framework that can be used for calculating exposure distribution at a set of future dates and, in particular, for calculating expected exposure profiles. This framework can be used for both regulatory and internal purposes. Additionally, we explained the treatment of margin agreements under the IMM that allows one to calculate the collateralized EPE measures: modeling collateralized exposure and the Shortcut Method. We discussed a general approach to modeling collateralized exposure that enables one to compute the collateral at a future date as a function of uncollateralized exposure at another date that precedes the primary date by the margin period of risk. Finally, we suggested a simple and fast method under this approach for modeling collateral that avoids the simulation of exposure at the secondary dates.

Keywords: Basel II, Collateral, Credit Exposure, Regulatory Capital and Counterparty Credit Risk

Suggested Citation

Pykhtin, Michael and Zhu, Steven H., Measuring Counterparty Credit Risk for Trading Products under Basel II (September 18, 2006). BASEL II HANDBOOK, Michael Ong, ed., RISK Books, 2006. Available at SSRN: https://ssrn.com/abstract=941551

Michael Pykhtin (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/econresdata/michael-v-pykhtin.htm

Steven H. Zhu

Banc of America Merrill Lynch ( email )

Bank of America Plaza
335 Madison Ave, 5th Floor
New York, NY 10017
United States
646-855-1853 (Phone)

HOME PAGE: http://www.riskwhoswho.com/Charter-Members.html

Morgan Stanley ( email )

1585 Broadway
New York, NY 10036
United States

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