Counterparty Credit Risk, Collateral and Funding

The book's content is focused on rigorous and advanced
quantitative methods for the pricing and hedging of counterparty
credit and funding risk. The new general theory that is required
for this methodology is developed from scratch, leading to a
consistent and comprehensive framework for counterparty credit and
funding risk, inclusive of collateral, netting rules, possible
debit valuation adjustments, re-hypothecation and closeout rules.
The book however also looks at quite practical problems, linking
particular models to particular 'concrete' financial
situations across asset classes, including interest rates, FX,
commodities, equity, credit itself, and the emerging asset class of
longevity.

The authors also aim to help quantitative analysts, traders, and
anyone else needing to frame and price counterparty credit
and funding risk, to develop a 'feel' for applying
sophisticated mathematics and stochastic calculus to solve
practical problems.

The main models are illustrated from theoretical formulation to
final implementation with calibration to market data, always
keeping in mind the concrete questions being dealt with. The
authors stress that each model is suited to different situations
and products, pointing out that there does not exist a single model
which is uniformly better than all the others, although the
problems originated by counterparty credit and funding risk point
in the direction of global valuation.

Finally, proposals for restructuring counterparty credit risk,
ranging from contingent credit default swaps to margin lending, are
considered.

Autorentext

About the authors 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 Banca IMI 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 Mathematics and an MSc in Economics. ANDREA PALLAVICINI is Head of Equity, FX and Commodity Models at Banca IMI, where he has the responsibility of numerical algorithm's design, financial modelling and research activity. He is also Visiting Professor at the Department of Mathematics of the Imperial College London. Previously, he held positions as Head of Financial Models at Mediobanca and Head of Financial Engineering at Banca Leonardo, he worked also in aerospace industries and financial institutions. He has a Degree in Astrophysics and a Ph.D. in Theoretical and Mathematical Physics from the University of Pavia for his research activity at CERN laboratory in Genève. Over the years he has written books in finance and he published several academic and practitioner-oriented articles in financial modelling, theoretical physics and astrophysics in major peer-reviewed journals. He teaches regularly at professional training courses and at Master and Ph.D. courses in finance at different Universities and private institutions. His main contributions in finance concern interest-rate and credit modelling, counterparty credit risk, and hybrid derivative pricing.

Zusammenfassung
The book's content is focused on rigorous and advanced quantitative methods for the pricing and hedging of counterparty credit and funding risk. The new general theory that is required for this methodology is developed from scratch, leading to a consistent and comprehensive framework for counterparty credit and funding risk, inclusive of collateral, netting rules, possible debit valuation adjustments, re-hypothecation and closeout rules. The book however also looks at quite practical problems, linking particular models to particular 'concrete' financial situations across asset classes, including interest rates, FX, commodities, equity, credit itself, and the emerging asset class of longevity.

The authors also aim to help quantitative analysts, traders, and anyone else needing to frame and price counterparty credit and funding risk, to develop a 'feel' for applying sophisticated mathematics and stochastic calculus to solve practical problems.

The main models are illustrated from theoretical formulation to final implementation with calibration to market data, always keeping in mind the concrete questions being dealt with. The authors stress that each model is suited to different situations and products, pointing out that there does not exist a single model which is uniformly better than all the others, although the problems originated by counterparty credit and funding risk point in the direction of global valuation.

Finally, proposals for restructuring counterparty credit risk, ranging from contingent credit default swaps to margin lending, are considered.

Inhalt

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

2.5.1 The Credit Support Annex (CSA) 39

2.5.2 The ISDA Proposal for a New Standard CSA 40

2.5.3 Collateral Effectiveness as a Mitigant 40

2.6 Funding 41 …