Measuring counterparty credit exposure to a margined counterparty
Abstract: Firms active in OTC derivative markets increasingly use margin agreements to reduce counterparty credit risk. Making several simplifying assumptions, I use both a quasi- analytic approach and a simulation approach to quantify how margining reduces counterparty credit exposure. Margining reduces counterparty credit exposure by over 80 percent, using baseline parameter assumptions. I show how expected positive exposure (EPE) depends on key terms of the margin agreement and the current mark-to-market value of the portfolio of contracts with the counterparty. I also discuss a possible shortcut that could be used by firms that can model EPE without margin but cannot achieve the higher level of sophistication needed to model EPE with margin.
File(s): File format is text/html http://www.federalreserve.gov/pubs/feds/2005/200550/200550abs.html
File(s): File format is application/pdf http://www.federalreserve.gov/pubs/feds/2005/200550/200550pap.pdf
Part of Series: Finance and Economics Discussion Series
Publication Date: 2005