Close-out convention tensions

Close-out convention tensions

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When a default event happens to one of the counterparties in a deal, it is stopped and marked-to-market: the net present value (NPV) of the residual part of the deal is calculated. The recovery rate is applied to this close-out value to determine the default payment. While modelling the recovery is known to be a difficult task, the calculation of the close-out amount has never been the focus of extensive research. Before the credit crunch, and actually up to the Lehman Brothers default in 2008,

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