Foreign Exchange Options and Risk Management

Foreign Exchange Options and Risk Management

Credit Derivatives

Credit Derivatives

Counterparty Credit Risk


This book is a collection of analyses of methods and practices used to manage OTC derivative counterparty risk and their performance during the 2007-8 financial crisis. It covers the areas of counterparty risk measurement, pricing (CVA), hedging, collateralization, stress testing, back testing and integration into economic capital frameworks. Various new ideas, directions and models are discussed by a group of seasoned experts. The content of the book is even more relevant in light of the recent proposals of the Basel Committee of Banking Supervision for the changes in the regulatory capital on counterparty risks.

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The Basel Committee for Banking Supervison (BCBS) has issued a substantive package of changes to the regulatory framework around counterparty credit risks in response to the events of the financial crisis of 2007-8. During this crisis, as in prior, counterparty credit risks have been at the center stage of the most crucial episodes.

Our book examines key aspects of counterparty risk management and models during the crisis and proposes practical guidance to improvements.

It contains a worth of insights useful to practitioners, regulators, consultants, accountants, lawmakers, auditors and researchers to understand the substantive, and often technical, issues on the table.

The book is a collection of clear and concise articles produced by some of the most experienced and prominent professionals in the field. All of them strived to produce material that is substantive and accessible. This provides an invaluable collection of ideas and tools to face the changes and challenges ahead and address some of the most important issues of the moment:

  • The proposed changes in counterparty risk capital may cause regulatory capital on credit risk to double
  • Banks will have to invest enormous resources to upgrade their counterparty risk management systems
  • Methods and process will be enhanced to address the demands on the governance of wrong-way risks, model validation and backtesting, and stress testing
  • CVAs and the market risk management of counterparty risks is key under the ruling of FAS 157 and IAS 39

The book consists of 14 chapters broken down into four broad areas:

· Chapters 1 to 5 cover topics related to counterparty risk measurement and management. It focuses on two very current subjects: systemic counterparty risk and collateralization.

· Chapters 6 to 10 cover topics related to the pricing and hedging of counterparty risks and of collateral arrangements. CVAs have caused massive losses to banks during the recent crisis and have motivated some of the recent the Basel Committee’s proposals for reforms of the regulatory capital on counterparty risks. The implications of collateral to OTC derivative valuation, funding costs and availability of funding are important current issues that are covered.

· Chapters 11 and 12 cover stress testing of counterparty risks. The recent experience made clear that stress tests frameworks need to be expanded and enhanced and some new and promising ideas are described.

· Chapters 13 and 14 cover back-testing of counterparty exposure models and the incorporation of counterparty risks into economic and regulatory capital frameworks.

More Information
ISBN 9781906348342
Navision code MCPR
Publication date 30 Mar 2010
Size 155mm x235mm
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Eduardo Canabarro

Eduardo Canabarro is the Managing Director responsible for Quantitative Risk Management at Morgan Stanley. He is responsible for the development of the methods and models used to measure market and credit risks as well as for the independent review and validation of pricing and risk models used by the bank. Prior to Morgan Stanley, he had a similar position at Lehman Brothers as Managing Director and Global Head of Quantitative Risk Management. Eduardo has also worked for Goldman Sachs and Salomon Brothers in Quantitative Modeling and Risk Management. Eduardo has published various articles in the Journal of Financial Engineering, Journal of Fixed Income, The Journal of Risk Financing, Journal of Risk and Re-Insurance, and RISK. His articles ?Counterparty Risk: Measurement and Pricing’ and ?Analyzing Counterparty Risk’ were cornerstones for the Basel II framework for regulatory capital on counterparty credit risk. He has spoken at leading risk management events around the world including the ones sponsored by the Wharton School, BIS, ICBI, RISK, PRMIA and IAFE. Eduardo holds degrees in Electrical Engineering and MBA (Finance) from UFRGS Brazil as well as MS and PhD degrees in Finance from University of California at Berkeley, USA.


Section 1: Counterparty risk measurement and management

Ch. 1 Systemic Counterparty Credit Risk – Aaron Brown

Ch. 2 Collateralized Credit Exposure - Michael Pykhtin

Ch. 3 Efficient Derivation of Counterparty Exposure at Default for Trading Book Credit Risk Economic Capital - David Rowe, Dan Travers and Phillip Koop

Ch. 4 Effective Enterprise-wide Collateral Management - Darren Measures

Ch. 5 Evolution of the US Legal Framework for Counterparty Risk Mitigation – Lauren Teigland-Hunt

Section 2: Counterparty risk pricing and hedging

Ch. 6 Pricing and Hedging Counterparty Risk: Lessons Re-Learned? – Eduardo Canabarro

Ch. 7 The Counterparty Risk of Credit Derivative Products – Jon Gregory

Ch. 8 Contingent Credit Default Swaps - Shankar Mukherjee, Andrew Hollings and Svein Stokke

Ch. 9 Funding Benefit and Funding Cost - Yi Tang and Andrew Williams

Ch.10 Generalized Valuation of Collateralized Derivatives - Patrick Chen, Katsuichiro Uchiyama and Guanghua Cao

Section 3: Stress testing of counterparty risk

Ch. 11 Stress Testing and Scenario Analysis: Some Second Generation Approaches - Gregory Hopper

Ch. 12 Computing and Stress Testing Counterparty Credit Risk Capital - Dan Rosen and David Saunders

Section 4: Backtesting and risk capital of counterparty risk

Ch. 13 Back(testing) to the Future: From Market Risk to Counterparty Credit Risk Models - Eduardo Epperlein, Sean Paul Hrabak, Wei Zhu and Alan Smillie

Ch. 14 Economic Capital on Counterparty Risks - Evan Picoult