CVA models may miss half of true default risk
Benefits of initial margin also overstated, new research finds
Conventional means of calculating credit risk in an over-the-counter derivatives trade can understate the true exposure by up to half, new research has found – a consequence of simplifying assumptions about the way a default works.
The researchers also cast doubt on the effectiveness of initial margin for derivatives trades, saying it will provide less protection than desired – that is, reducing overall exposure by only a factor of 10, rather than the expected factor of 120. They argue the
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