Capturing credit correlation between counterparty and underlying

Cutting Edge

The conventional approach to calculating counterparty exposure assumes that the underlying of the derivative and the counterparty credit quality are uncorrelated. There are many cases, however, where this assumption does not necessarily hold. Examples of these cases include emerging market currencies, commodity producers hedging future production and credit derivatives. In this article, we focus on the case of credit derivatives where the underlying reference entities are correlated with the