Credit Risk Management for Derivatives Post Crisis Metrics for End Users 1st Edition by Ivan Zelenko ISBN 3319579754 9783319579757

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ISBN 10: 3319579754 
ISBN 13: 9783319579757
Author: Ivan Zelenko

This Palgrave Pivot assesses the impact of the regulatory framework for derivatives built post-crisis and examines its ambition to centralize and minimize credit risk, enhance transparency, and regain control. Zelenko delves into the powerful destabilizing forces exerted by derivatives markets in the global financial meltdown of 2008. Recapping the evolution in markets and counterparty risk management, as well as key aspects of regulation and their impact, this book aims to give readers the big picture and foster a deep understanding of the role of derivatives markets in the financial crisis. This practical angle will give useful keys to end-users and their risk managers, as they are faced with a new, complex, and changing environment. Additionally, this book conducts a comprehensive analysis of the new metrics the market has created to model, price, and manage credit risk, such as the Credit Value Adjustment (CVA), the Debt Value Adjustment (DVA), or the Funding Value Adjustment (FVA), and takes full stock of a domain that is still in rapid evolution. This volume covers the concepts, methods, and approaches taken by banks to manage counterparty credit risk in their derivatives activities in the new post-crisis market and regulatory environment, and it aims to highlight what is practical and effective today.

Credit Risk Management for Derivatives Post Crisis Metrics for End Users 1st Table of contents:

1 Derivatives as Mass Destruction Power

1.1 The Most Severe Crisis Since 1929

1.2 The Cause: New Destructive Forces Add to Excess Leverage

1.3 The Culprits: Opacity, Complexity, and Derivatives

2 Regaining Control

2.1 The Post-2008 Regulatory Agenda

2.2 The Implementation: Seven Years After Pittsburgh

2.3 The Impact: Curbing Derivatives Credit Risk

3 A Still Uncomplete Reshaping

3.1 The Limitations of the New Framework

3.2 The Unintended Consequences

3.3 The New Systemic Threat

References

Outlining Counterparty Credit Risk Exposure

Abstract

1 Counterparty Credit Risk and OTC Derivatives

1.1 Definition: The Essence of Counterparty Credit Risk

1.2 The Growing Recognition of Counterparty Credit Risk

2 Credit Risk in Derivative Pricing

2.1 The Long Reliance on Libor as a Risk-Free Rate Proxy

2.2 The Deficiencies of the Libor Rate After 2008

2.3 The New Risk-Free Rate for Pricing Derivatives: The OIS

3 Counterparty Credit Risk Exposure Metrics

3.1 Measure at Portfolio Level: Netting Set

3.2 Key Aspects of Counterparty Risk Exposure Metrics

3.2.1 Rest on Future MtM Probability Distributions and Simulations

3.2.2 Define Exposure as per the ISDA Contract and Reflect Collateral

3.2.3 Focus on Positive Exposure Only

3.2.4 Reflect the “Time Element” of Derivative’s Exposure

3.3 Basic Intuitions on Swap Credit Exposure

3.4 Main Counterparty Credit Risk Exposure Metrics

3.4.1 Over the Entire Portfolio’s Life: (EPE), Effective EPE

4 Wrong-Way Risk

4.1 Wrong-Way Risk in Practice

4.2 Wrong-Way Risk Measure

References

Restating the Role of Collateral

Abstract

1 The Destination of Collateral

1.1 The Concept: A Dynamic and Symmetric Protection Against Counterparty Risk

1.2 The Adoption: Collateral as a Standard of OTC Derivatives

1.3 The Implementation: Key Clauses in the CSA

2 The Art of Managing Collateral

2.1 The Art of Receiving Collateral: The Credit Support Amount (CSA)

2.2 The Art of Receiving Collateral: Settling Disputes

2.3 The Art of Receiving Collateral: Eligible Instruments

2.4 The Art of Posting Collateral: Minimizing the Cost

2.5 The Art of Posting Collateral: Re-Hypothecation

3 The Shortcomings of Collateral and the Margin Call Risk

3.1 Collateralization Shortcomings

3.1.1 Replacement Risk and PFE

3.1.2 Credit Risk on Posted Collateral

3.1.3 Re-Hypothecation or Segregation

3.2 Collateral Liquidity Risk or “Margin Call Risk”

3.2.1 A Short Analysis of the Margin Call Risk

3.2.2 Margin Call Risk in the Recent History of Finance

4 An Enhanced Systemic Risk Mitigation Role

4.1 The Status of Collateral in Post-2008 Regulation

4.2 Reforms to Enhance Credit Protection

4.2.1 Initial Margin for Replacement Risk and PFE

4.2.2 Protecting the Value of the Collateral Received

4.2.3 Dealing with Liquidity Risk Aspects

References

Adjusting for Credit and Debt Value: CVA and DVA

Abstract

1 Credit Value Adjustment: CVA

1.1 CVA: Definition and Overview

1.2 CVA Formula

1.2.1 CVA Formula with Probabilities of Default

1.2.2 CVA Formula with Credit Spreads

1.3 CVA Formula with Collateral

1.4 CVA Formula with Credit Risk on Collateral

2 DVA and Bilateral Adjustment

2.1 DVA: Definition and Overview

2.2 DVA Formula

2.2.1 DVA Formula with Probabilities of Default

2.2.2 DVA Formula with Credit Spreads

2.3 DVA Formula with Collateral

2.4 DVA Formula with Credit Risk on Collateral

2.5 CVA and DVA: Bilateral Adjustment Formula

3 CVA and DVA in Finance Theory

3.1 A Canonic Financial Market Framework

3.2 3.2. Forward Rate Agreement (FRA) and Swap Pricing

3.3 Defaultable Bonds Modeling

3.3.1 Modeling Default in a Reduced Form

3.3.2 Pricing of Defaultable Bonds

3.4 Defaultable Swaps Modeling: CVA

3.4.1 CVA: Formal Expression Without Collateral

3.4.2 CVA: Formula in a Discretized Time Frame Without Collateral

3.4.3 CVA: Formal Expression with Collateral

3.4.4 CVA: Formal Expression with Credit Risk on Collateral

3.5 DVA

3.5.1 DVA Formal Expression Without Collateral

3.5.2 DVA Formula in a Discretized Time Frame Without Collateral

3.5.3 DVA Formal Expression for a Portfolio with Collateral

3.5.4 DVA Formal Expression with Credit Risk on Collateral

3.6 Bilateral CVA

Expanding Valuation Metrics: FVA and KVA

Abstract

1 Funding Value Adjustment: FVA

1.1 FVA: Definition and Background

1.2 FVA and the Cost of Funding Collateral

1.3 The FVA Debate

1.4 A FVA Formula

2 Capital Charge and KVA

2.1 Capital Requirements for Derivatives Counterparty Credit Risk

2.2 KVA Formula

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