Cutting edge intro: Righting wrong-way risk

Models that describe wrong-way risk should move away from simplistic copula models, critics say.


Tightening their grip on banks, regulators have laid out specific guidelines for almost all aspects of pricing and risk management, such as the calculation of regulatory capital, credit valuation adjustment and its associated capital charge. Surprisingly, the modelling of wrong-way risk, the rather inconvenient dependence between exposure and credit quality of the counterparty, is still left to the skill and imagination of quants.

Wrong-way risk is a tough beast to tame. Its modelling inherently

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