The Credit Risk Management of Derivative Portfolios: Qualitative Issues

In Parts II and III of this text we have introduced fundamental methods for identifying and quantifying the credit risk of various derivative structures, and in the previous chapter we have discussed various techniques for quantifying derivative credit exposure on a portfolio basis; in this chapter we address a number of qualitative issues related to the management of derivative portfolios. In the first section below we explore the dynamic management of derivative exposures, which is most often accomplished through credit risk mitigation techniques, credit risk simulations/scenario analyses, and dynamic limit adjustment; such dynamic risk management is generally monitored through a comprehensive credit system infrastructure. In the second section of the chapter we consider a range of ancillary credit risk management issues which analysts are increasingly required to address; these topics include counterparty motivation for entering into derivative transactions (and the suitability of entering into such transactions), relevance of credit analysis in an era of lengthening transaction maturities, and problems posed by a counterparty’s unwillingness to perform on its derivative obligations (rather than its financial inability to perform on such obligations, which is the domain of traditional credit analysis). The quantitative aspects of credit risk management presented in Chapter 8 and the qualitative aspects presented in this chapter combine to form an overall framework for the ongoing management of derivative credit risk exposures.