Counterparty Credit Risk

The first decade of the 21st Century has been disastrous forfinancial institutions, derivatives and risk management.Counterparty credit risk has become the key element of financialrisk management, highlighted by the bankruptcy of the investmentbank Lehman Brothers and failure of other high profile institutionssuch as Bear Sterns, AIG, Fannie Mae and Freddie Mac. The suddenrealisation of extensive counterparty risks has severelycompromised the health of global financial markets. Counterpartyrisk is now a key problem for all financial institutions.This book explains the emergence of counterparty risk during therecent credit crisis. The quantification of firm-wide creditexposure for trading desks and businesses is discussed alongsiderisk mitigation methods such as netting and collateral management(margining). Banks and other financial institutions have beenrecently developing their capabilities for pricing counterpartyrisk and these elements are considered in detail via acharacterisation of credit value adjustment (CVA). The implicationsof an institution valuing their own default via debt valueadjustment (DVA) are also considered at length. Hedging aspects,together with the associated instruments such as credit defaultsswaps (CDSs) and contingent CDS (CCDS) are described in full.A key feature of the credit crisis has been the realisation ofwrong-way risks illustrated by the failure of monoline insurancecompanies. Wrong-way counterparty risks are addressed in detail inrelation to interest rate, foreign exchange, commodity and, inparticular, credit derivative products. Portfolio counterparty riskis covered, together with the regulatory aspects as defined by theBasel II capital requirements. The management of counterparty riskwithin an institution is also discussed in detail. Finally, thedesign and benefits of central clearing, a recent development toattempt to control the rapid growth of counterparty risk, isconsidered.This book is unique in being practically focused but alsocovering the more technical aspects. It is an invaluable completereference guide for any market practitioner with any responsibilityor interest within the area of counterparty credit risk.