Outlining Counterparty Credit Risk Exposure

This chapter examines the very nature of Counterparty Credit Risk (CCR), or the manifestation of Credit and Default Risk in derivatives contracts, in which the exposure is measured at the level of a “Netting Set” of contracts, can change sign over time, and tends to be mitigated by the periodic posting of collateral. The chapter reviews how the growing awareness of CCR, considerably amplified by the 2008 crisis, has led to the entire revision of pricing methodologies for derivatives: inclusion of the Credit and Debt Value Adjustments, replacement of the Libor curve by the OIS curve (Overnight Index Swap) as the reference curve for discounting cash flows. The chapter then presents key metrics for measuring Counterparty Exposure and analyses the special case of Wrong-Way risk.