RESTRUCTURING COUNTERPARTY CREDIT RISK

Claudio Albanese, Damiano Brigo and Frank Oertel ()
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Frank Oertel: School of Mathematics, University of Southampton, Highfield, Southampton, SO17 1BJ, UK

International Journal of Theoretical and Applied Finance (IJTAF), 2013, vol. 16, issue 02, 1-29

Abstract: We introduce an innovative theoretical framework for the valuation and replication of derivative transactions between defaultable entities based on the principle of arbitrage freedom. Our framework extends the traditional formulations based on credit and debit valuation adjustments (CVA and DVA). Depending on how the default contingency is accounted for, we list a total of ten different structuring styles. These include bi-partite structures between a bank and a counterparty, tri-partite structures with one margin lender in addition, quadri-partite structures with two margin lenders and, most importantly, configurations where all derivative transactions are cleared through a central counterparty clearing house (CCP). We compare the various structuring styles under a number of criteria including consistency from an accounting standpoint, counterparty risk hedgeability, numerical complexity, transaction portability upon default, induced behavior and macro-economic impact of the implied wealth allocation.

Keywords: Counterparty risk; credit risk; credit valuation adjustment; counterparty risk restructuring; CVA restructuring; DVA; margin lending; collateral (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (6)

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Working Paper: Restructuring Counterparty Credit Risk (2012)
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DOI: 10.1142/S0219024913500106

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