Journal of Credit Risk

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The pricing implications of counterparty risk for non-linear credit products

Stuart M. Turnbull

ABSTRACT

We describe a methodology for deriving the upper and lower profit and loss (P&L) bounds in the presence of counterparty risk that does not rely on either structural or reduced-form credit models. The methodology provides practitioners and regulators with a practical tool to estimate the impact on P&L of the two facets of counterparty risk: failure to perform and mark-to-market exposure. We show that for many applications, the bounds are tight and the creditworthiness of counterparties can have a major impact on the P&L.

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