Counterparty Credit Risk

Quantify and understand the default risk of a counterparty

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

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

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

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

For more on counterparty credit risk, see MATLAB®, Financial Toolbox™, Financial Instruments Toolbox™, and Risk Management Toolbox™.

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