CVA models may miss half of true default risk

Benefits of initial margin also overstated, new research finds

Hidden credit risk lies beneath the surface of the OTC market

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