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Default Risk and Derivatives: An Empirical Analysis of Bilateral Netting

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  • Marianne Gizycki

    (Reserve Bank of Australia)

  • Brian Gray

    (Reserve Bank of Australia)

Abstract

This paper discusses the determination of a capital charge to cover default risk on a netted derivatives portfolio. Different methods of setting a capital charge are investigated. Their ability to track a more sophisticated measure of credit risk is tested for Australian banks’ portfolios. The effect on the level of credit risk of moving from an environment without bilateral netting, to one where netting has firm legal basis, is examined. We find that, while there are theoretical grounds for arguing that more sophisticated measures would track exposures more closely than the approach currently used in capital adequacy requirements, as an empirical matter, no single formulation clearly outranked any other.

Suggested Citation

  • Marianne Gizycki & Brian Gray, 1994. "Default Risk and Derivatives: An Empirical Analysis of Bilateral Netting," RBA Research Discussion Papers rdp9409, Reserve Bank of Australia.
    • Handle: RePEc:rba:rbardp:rdp9409
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    File URL: https://www.rba.gov.au/publications/rdp/1994/pdf/rdp9409.pdf
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    References listed on IDEAS

    as
    1. Katerina Simons, 1993. "Interest rate structure and the credit risk of swaps," New England Economic Review, Federal Reserve Bank of Boston, issue Jul, pages 23-34.
    2. Mark E. Levonian, 1994. "Bank capital standards for foreign exchange and other market risks," Economic Review, Federal Reserve Bank of San Francisco, pages 3-18.
    3. Longstaff, Francis A & Schwartz, Eduardo S, 1992. "Interest Rate Volatility and the Term Structure: A Two-Factor General Equilibrium Model," Journal of Finance, American Finance Association, vol. 47(4), pages 1259-1282, September.
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    Cited by:

    1. Anthony Brassil & Jon Cheshire & Joseph Muscatello, 2018. "The Transmission of Monetary Policy through Banks' Balance Sheets," RBA Annual Conference Volume (Discontinued), in: John Simon & Maxwell Sutton (ed.),Central Bank Frameworks: Evolution or Revolution?, Reserve Bank of Australia.
    2. Dominic O’Kane, 2017. "Optimising the multilateral netting of fungible OTC derivatives," Quantitative Finance, Taylor & Francis Journals, vol. 17(10), pages 1523-1534, October.

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