Wrong-way risk done right

Here, Jacky Lee and Luca Capriotti present an arbitrage-free valuation framework for the counterparty exposure of credit derivatives portfolios. The method is able to consistently capture the effects of credit spread volatility and credit correlations. By introducing fast semi-analytical approximations, they demonstrate how the proposed approach can be used to handle large portfolios of credit default swaps under financially realistic models of default intensities

Wrong way sign

One of the more pressing challenges facing today’s securities dealers is to account reliably, and risk-manage effectively, the various valuation adjustments (XVA) arising from counterparty risk, funding and other capital charges. This is especially challenging for credit derivatives portfolios as the accurate calculation of counterparty exposure requires modelling both default and spread correlations in a consistent framework to capture the effects of so-called wrong-way risk (WWR). In the

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Credit risk & modelling – Special report 2021

This Risk special report provides an insight on the challenges facing banks in measuring and mitigating credit risk in the current environment, and the strategies they are deploying to adapt to a more stringent regulatory approach.

The wild world of credit models

The Covid-19 pandemic has induced a kind of schizophrenia in loan-loss models. When the pandemic hit, banks overprovisioned for credit losses on the assumption that the economy would head south. But when government stimulus packages put wads of cash in…

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