Journal of Credit Risk

Backtesting counterparty risk: how good is your model?

Ignacio Ruiz


Backtesting counterparty credit risk (CCR) models is anything but simple. Such backtesting is becoming increasingly important in the financial industry since both the CCR capital charge and credit valuation adjustment (CVA) management have become even more central to banks. In spite of this, there are no clear guidelines from regulators on how to perform this backtesting. This is in contrast to market risk models, where the Basel Committee set a strict set of rules in 1996, which are widely followed. In this paper, we explain a quantitative methodology to backtest counterparty risk models. We expand the three-color Basel Committee scoring scheme from the market risk to the CCR framework. This framework can be applied to single or multifactor models. With this methodology, each model can be assigned a color score for each chosen time horizon. Financial institutions can then use this framework to assess the need for model enhancements and to manage model risk. We have implemented this framework in a Tier-1 financial institution; the model report it generated was sent to the regulators for internal model methods approval. The model was approved a few months later.

Sorry, our subscription options are not loading right now

Please try again later. Get in touch with our customer services team if this issue persists.

New to View our subscription options

You need to sign in to use this feature. If you don’t have a account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an individual account here