Counterparty - credit risk, collateral and funding

Ignition xv
 
Abbreviations and Notation xxiii
 
PART I COUNTERPARTY CREDIT RISK, COLLATERAL AND FUNDING
 
1 Introduction 3
 
1.1 A Dialogue on CVA 3
 
1.2 Risk Measurement: Credit VaR 3
 
1.3 Exposure, CE, PFE, EPE, EE, EAD 5
 
1.4 Exposure and Credit VaR 7
 
1.5 Interlude: P and Q 7
 
1.6 Basel 8
 
1.7 CVA and Model Dependence 9
 
1.8 Input and Data Issues on CVA 10
 
1.9 Emerging Asset Classes: Longevity Risk 11
 
1.10 CVA and Wrong Way Risk 12
 
1.11 Basel III: VaR of CVA and Wrong Way Risk 13
 
1.12 Discrepancies in CVA Valuation: Model Risk and Payoff Risk 14
 
1.13 Bilateral Counterparty Risk: CVA and DVA 15
 
1.14 First-to-Default in CVA and DVA 17
 
1.15 DVA Mark-to-Market and DVA Hedging 18
 
1.16 Impact of Close-Out in CVA and DVA 19
 
1.17 Close-Out Contagion 20
 
1.18 Collateral Modelling in CVA and DVA 21
 
1.19 Re-Hypothecation 22
 
1.20 Netting 22
 
1.21 Funding 23
 
1.22 Hedging Counterparty Risk: CCDS 25
 
1.23 Restructuring Counterparty Risk: CVA-CDOs and Margin Lending 26
 
2 Context 31
 
2.1 Definition of Default: Six Basic Cases 31
 
2.2 Definition of Exposures 32
 
2.3 Definition of Credit Valuation Adjustment (CVA) 35
 
2.4 Counterparty Risk Mitigants: Netting 37
 
2.5 Counterparty Risk Mitigants: Collateral 38
 
2.6 Funding 41
 
2.7 Value at Risk (VaR) and Expected Shortfall (ES) of CVA 43
 
2.8 The Dilemma of Regulators and Basel III 44
 
3 Modelling the Counterparty Default 47
 
3.1 Firm Value (or Structural) Models 47
 
3.2 Firm Value Models: Hints at the Multiname Picture 64
 
3.3 Reduced Form (Intensity) Models 65
 
3.4 Intensity Models: The Multiname Picture 78
 
PART II PRICING COUNTERPARTY RISK: UNILATERAL CVA
 
4 Unilateral CVA and Netting for

Professor Damiano Brigo is Chair of Mathematical Finance and co-Head of Group at Imperial College, London. Damiano is also Director of the Capco Research Institute. His previous roles include Gilbart Professor and Head of Group at King's College, Managing Director and Global Head of Quantitative Innovation in Fitch, Head of Credit Models in Banca IMI, Fixed Income Professor at Bocconi University in Milan, and Quantitative Analyst at Banca Intesa. He has worked on quantitative analysis of counterparty risk, interest rates-, FX-, credit- and equity- derivatives, risk management and structured products, and funding costs and collateral modelling. Damiano has published 70+ works in top journals for Mathematical Finance, Systems Theory, Probability and Statistics, with H-index 24 on Scholar, and books for Springer and John Wiley & Sons that became field references in stochastic interest rate and credit modelling. Damiano is Managing Editor of the International Journal of Theoretical and Applied Finance, and has been listed as the most cited author in Risk Magazine in 2006 and 2010. Damiano obtained a Ph.D. in stochastic filtering with differential geometry in 1996 from the Free University of Amsterdam, following a BSc in Mathematics with honours from the University of Padua.
 
Massimo Morini is Head of Interest Rate and Credit Models and Coordinator of Model Research at IMI Bank of Intesa San Paolo. Massimo is also Professor of Fixed Income at Bocconi University and was a Research Fellow at Cass Business School, City University London. He regularly delivers advanced training in London, New York and worldwide. He has led workshops on credit risk and the financial crisis at major international conferences. He has published papers in journals including Risk Magazine, Mathematical Finance, and the Journal of Derivatives, and is the author of Understanding and Managing Model Risk: A Practical Guide for Quants, Traders and Validators. Massimo holds a PhD in