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Credit Risk Frontiers: Subprime Crisis, Pricing and Hedging, CVA, MBS, Ratings, and Liquidity by Frédéric Patras, Damiano Brigo, Tomasz R. Bielecki

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Chapter 16

Counterparty Risk Management and Valuation

Michael Pykhtin3

Federal Reserve Board

In this chapter, we give an overview of approaches to managing counterparty credit risk (CCR) and review different aspects of modeling CCR. We define counterparty credit exposure for a stand-alone derivative contract and then extend this definition to a portfolio of contracts. We show how netting agreements reduce counterparty-level exposure and briefly describe the basic principles of simulating exposure. We introduce the concept of exposure profile and illustrate it with examples. Then we turn to collateralization and show how margin agreements can further reduce credit exposure. We formally define collateralized exposure and discuss popular approaches ...

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