Counterparty Credit Risk

What Is Counterparty Credit Risk?

Counterparty credit risk is the potential for a loss arising from the default event of a counterparty in financial contracts (e.g., derivative contracts and securities borrowing and lending agreements). The credit risk of a counterparty in a depends on various factors, for instance, value of underlying assets, type of netting agreements, and value of collateral.

Understanding counterparty credit risk help financial institutions set the counterparty credit limits and policy, which help mitigate losses when the credit events occur.

Risk managers commonly use various mathematical techniques to quantify and assess counterparty credit risk, including:

  • Simulating default events using Copulas
  • Estimating transition probabilities of credit ratings
  • Pricing of financial instruments (e.g., swaps, options, forwards)

See also: financial derivatives, credit risk, credit scoring model, risk management, fraud analytics