Counterparty Credit Risk

Abstract

Abstract Counterparty credit risk (CCR) is the risk that a counterparty in a financial contract will default prior to the expiration of the contract and will fail to make all the payments required by the contract. In this article, we briefly describe approaches to managing CCR and review different aspects of modeling CCR. We define counterparty credit exposure for a single derivative contract and then extend this definition to a portfolio of contracts. We show how netting and margin agreements affect the exposure. For margin agreements, we describe the standard approach to modeling available collateral. The article also covers pricing CCR via credit valuation adjustment (CVA) and modeling portfolio loss and economic capital.

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