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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
Measuring counterparty credit exposure to a margined counterparty
Michael S. Gibson
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.


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Michael S. Gibson, Measuring counterparty credit exposure to a margined counterparty, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2005-50, 2005.
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Keywords: Risk management ; Derivative securities ; Over-the-counter markets
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