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Measuring counterparty credit exposure to a margined counterparty

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Abstract

Firms active in OTC derivative markets increasingly use margin agreements to reduce counterparty credit risk. Making several simplifying assumptions, I use both a quasi- analytic approach and a simulation approach to quantify how margining reduces counterparty credit exposure. Margining reduces counterparty credit exposure by over 80 percent, using baseline parameter assumptions. I show how expected positive exposure (EPE) depends on key terms of the margin agreement and the current mark-to-market value of the portfolio of contracts with the counterparty. I also discuss a possible shortcut that could be used by firms that can model EPE without margin but cannot achieve the higher level of sophistication needed to model EPE with margin.

Suggested Citation

  • Michael S. Gibson, 2005. "Measuring counterparty credit exposure to a margined counterparty," Finance and Economics Discussion Series 2005-50, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2005-50
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    Cited by:

    1. Harb, Etienne & Louhichi, Wael, 2017. "Pricing CDS spreads with Credit Valuation Adjustment using a mixture copula," Research in International Business and Finance, Elsevier, vol. 39(PB), pages 963-975.
    2. Li, Shuang & Peng, Cheng & Bao, Ying & Zhao, Yanlong, 2020. "Explicit expressions to counterparty credit exposures for Forward and European Option," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).

    More about this item

    Keywords

    Risk management; Derivative securities; Over-the-counter markets;
    All these keywords.

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