Hot answers tagged

9

Options are actually some of the least susceptible securities to the adverse impact of counterparty risk. I refer to listed options, such as those cleared through the OCC (Options Commodity Clearinghouse) in Chicago, IL. The OCC is a true central clearing counterparty (CCC) because it bears all default risk, by distributing it evenly among its members. The ...


8

The short answer is that it depends ;-) The long answer is complicated because it is a complicated topic. Disclaimers: I am not a lawyer (feel free to comment if I have overlooked anything) I believe the information below to be fairly standard, but counterparty risk is eventually driven by contracts and has to be envisaged on a case by case basis Cash is ...


6

Keep in mind that most futures, equity, and index options, at least, are traded on exchanges where the counterparty risk is so tiny as to be negligible. In general, adding extra variables like this fails to invalidate the model. For example, the fact that interest rates or volatilities are not constant just ends up leading to an extended model with extra ...


4

There is a good article in Seeking Alpha but if you did a Google Search you probably found it already. Some ETF's work through swaps with a counterpart, but you will never know who the counter-part is. As you said it depends on the type of ETF, with a UCITS ETF you're not supposed to have a big counter-part risk as you own the underlyings, when it's ...


4

@Gordon, here is how I would interpret this excerpt. Assume that the discussion starts with $\bf{SALVA}$ explaining to $\bf{SAGE}$ that, in the absence of arbitrage opportunities, it is always possible to identify an equivalent martingale measure (EMM) $\mathbb{Q}$ under which prices of financial instruments can be written as expectations, with no concern ...


3

I think the easiest way to explain this is with an example of a spread trade. Consider a curve trade on WTI crude oil such that you're short 1y oil and long 2y oil. 1y oil is at \$50 and 2y oil is at \$54. You have one contract on each leg for a gross exposure of \$104k and net exposure of \$4k. If 1y oil moves up \$5 to \$55 and 2y oil moves up \$6 to \$60, ...


3

The quanto adjustment is required to achieve the martingale property for the discounted payoff after currency transformation. Since you do not require discounted asset values to be martingales for risk measurement you do not need a quanto adjustment. But of course you need to include the distribution of future FX-rates in your modelling (which might be what ...


3

There is only one real world! You would use the measure that best describes all the markets together. Bear in mind that for credit you are really interested in portfolio effects. What is the potential credit risk we could have to a particular name? This depends on all the contracts we have them regardless of currency and they need to be modelled ...


2

I recommend you read the Financial Stability Board report. FT Alphaville provides a nice summary of the report with plenty of links to investigate further.


2

If each party uses unilateral CCR model, i.e. Only takes into account the other party's probability of default, they are much less likely to agree on a price and actually trade. In general, you want to take your own default into account simply because it is market observable through cds and bond spreads. And because it will affect your funding.


1

When you enter into a derivative trade, such as a swap, the intial value is zero; as interest rates change the value may become positive or negative. If it is positive and the counterparty defaults you could be out a big sum of money (imagine that you are trading with Lehman Brothers in 2008). The idea of PFE is to estimate at some time in the future the ...


1

This only produces an approximation. As per Gregory (page 256) However, adding a spread to a contract such as a swap, the problem is non-linear since the spread itself will have an impact on the CVA. The correct value should be calculated recursively (since the spread is risky too) until the risky MTM of the contract is zero. He points to a ...


1

I think the terminology often leads to confusion. Risk neutral pricing is essentially based on the idea of state prices or Arrow securities. One imagines or attempts to replicate securities that represent a state of the market. The price that is the consensus price of the market participants is the price of the Arrow security and this defines the state ...



Only top voted, non community-wiki answers of a minimum length are eligible