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Measuring counterparty credit exposure to a margined counterparty

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  • Michael S. Gibson
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    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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    File URL: http://www.federalreserve.gov/pubs/feds/2005/200550/200550abs.html
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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2005-50.

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    Date of creation: 2005
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    Handle: RePEc:fip:fedgfe:2005-50

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    Related research

    Keywords: Risk management ; Derivative securities ; Over-the-counter markets;

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