Statistical Issues in Managing the Credit Risk of Derivatives
Third Workshop on Mathematical Finance
October 20, 21, 1996
The Center for Applied Probability
Columbia University
Abstract
An over-the-counter financial derivative is a two-party contract
which may have a lifetime of several years. Such an agreement has
the potential to expose each party to the risk of default by the
other. It is important to be able to measure and manage this risk.
One important tool in managing it is the pledging of collateral from
one party to the other. Another is the credit-enhanced derivative
product company (DPC). Again, however, collateral plays an important
role in the structure of the typical DPC. Developing rules for
adequate levels of collateral and strategies to minimize its cost is
therefore a critical need, and statistical analysis and reasoning are
central to meeting that need.