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Whitepapers

As a recognised thought leader, Quantifi publishes whitepapers and articles that offer valuable insight on key topics related to the financial markets.

OIS and CSA Discounting

OIS and CSA Discounting

Prior to the credit crisis, interest rate modelling was generally well understood. The underlying fundamental principles had existed for over thirty years with steady evolutions in areas that were most relevant to options and complex products. Credit and liquidity were ignored as their effects were minimal. Pricing a single currency interest rate swap was straightforward. A single interest rate curve was calibrated to liquid market products and future cash flows were estimated and discounted using this single curve. There was little variation between implementations and results across the market were consistent.

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How the Credit Crisis Has Changed Counterparty Risk Management

How the Credit Crisis Has Changed Counterparty Risk Management

The credit crisis and regulatory responses have forced banks to substantially update their counterparty risk management processes. New regulations in the form of Basel III, the Dodd-Frank Act in the U.S. and European Market Infrastructure Regulation (EMIR) have dramatically increased capital requirements for Counterparty Credit Risk.

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Challenges in Implementing a Counterparty Risk Management Process

Challenges in Implementing a Counterparty Risk Management Process

Most banks are in the process of setting up counterparty risk management processes or improving existing ones. Unlike market risk, which can be effectively managed by individual trading desks or traders, counterparty risk is increasingly being priced and managed by a central CVA desk or risk control group since the exposure tends to span multiple asset classes and business lines. Moreover, aggregated counterparty exposure may be significantly impacted by collateral and cross-product netting agreements.

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CVA, DVA and Hedging Earnings Volatility

CVA, DVA and Hedging Earnings Volatility

Credit Value Adjustment (CVA) is the amount subtracted from the mark-to-market (MTM) value of derivative positions to account for the expected loss due to counterparty defaults. Debt Value Adjustment (DVA) is basically CVA from the counterparty’s perspective. If one party incurs a CVA loss, the other party records a corresponding DVA gain.

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The Evolution of Counterparty Credit Risk

The Evolution of Counterparty Credit Risk

Although the recent crisis has brought a heightened focus, counterparty credit risk theory and practice have been evolving for over a decade. Initially banks addressed the problem from their traditional financing experience while investment banks approached it from a derivatives perspective.

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CVA, DVA and Bank Earnings

CVA, DVA and Bank Earnings

Credit Value Adjustment (CVA) is the amount subtracted from the mark-to-market (MTM) value of derivative positions to account for the expected loss due to counterparty defaults. CVA is easy to understand in the context of a loan – it is the loan principal, minus anticipated recovery, multiplied by the counterparty’s default probability over the term of the loan. For derivatives, the loan amount is the net MTM value of derivative positions with that counterparty.

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Basel III and Systemic Risk

Basel III and Systemic Risk

Basel III substantially raises the amount and quality of core Tier one capital from 2% to 7%, plus introduces an additional countercyclical buffer of up to 2.5% and a discretionary surcharge for ‘systemically important’ institutions, i.e., the big dealers.

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