CVA hedging: a false sense of security
Hedges of derivatives counterparty credit exposure – when based on credit default swap spreads – are unreliable and may lull banks into ignoring tail risks, argues David Rowe
Analysis of counterparty credit exposure has come a long way since I first addressed the issue almost two decades ago (Risk November 1993, pages 52–55). Nevertheless, nothing in traditional exposure estimation takes account of the probability of default by the counterparty in a rigorous, quantitative way. Instead, judgemental assessment of the financial strength of a counterparty became the key determinant of how much potential future exposure credit officers would approve.
Even in the early
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