Statistics of Credit Risk Management in Financial Derivatives
Triangle Econometrics Conference
December 12, 1997
Abstract
An over-the-counter financial derivative transaction 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. Measuring and managing this risk may be critical to the survival
of the parties. One important tool in managing risk is the pledging of
collateral from one party to the other. Another is the use of a
high-credit intermediary, such as a special purpose vehicle (SPV) with
an enhanced credit rating. SPV's also depend heavily on the use of
collateral to achieve their ratings. Developing rules for adequate
levels of collateral and strategies to minimize its cost is therefore a
critical need; modern quantitative methods play a role in meeting that
need.