Counter party risk
Encyclopedia
Counterparty risk, otherwise known as default risk, is the risk that an organization does not pay out on a credit derivative
, credit default swap
, credit insurance
contract, or other trade or transaction when it is supposed to.[2] Even organizations who think that they have hedged their bets by buying credit insurance of some sort still face the risk that the insurer will be unable to pay, either due to temporary liquidity issues or longer term systemic issues.[3]
Large insurers are counterparties
to many transactions, and thus this is the kind of risk that prompts financial regulators
to act, e.g., the bailout of insurer AIG
.
On the methodological side, counterparty risk can be affected by wrong way risk, namely the risk that different risk factor
s be correlated in the most harmful direction. Including correlation between the portfolio risk factors and the counterparty default into the methodology
is not trivial, see for example Brigo and Pallavicini[4]
Credit derivative
In finance, a credit derivative is a securitized derivative whose value is derived from the credit risk on an underlying bond, loan or any other financial asset. In this way, the credit risk is on an entity other than the counterparties to the transaction itself...
, credit default swap
Credit default swap
A credit default swap is similar to a traditional insurance policy, in as much as it obliges the seller of the CDS to compensate the buyer in the event of loan default...
, credit insurance
Credit insurance
Credit insurance is a term used to describe both business credit insurance and consumer credit insurance, e.g., credit life insurance, credit disability insurance Credit insurance is a term used to describe both business credit insurance (a.k.a. trade credit insurance) and consumer credit...
contract, or other trade or transaction when it is supposed to.[2] Even organizations who think that they have hedged their bets by buying credit insurance of some sort still face the risk that the insurer will be unable to pay, either due to temporary liquidity issues or longer term systemic issues.[3]
Large insurers are counterparties
Counterparty
A counterparty is a legal and financial term. It means a party to a contract. A counterparty is usually the entity with whom one negotiates on a given agreement, and the term can refer to either party or both, depending on context....
to many transactions, and thus this is the kind of risk that prompts financial regulators
Financial regulation
Financial regulation is a form of regulation or supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the integrity of the financial system...
to act, e.g., the bailout of insurer AIG
AIG
AIG is American International Group, a major American insurance corporation.AIG may also refer to:* And-inverter graph, a concept in computer theory* Answers in Genesis, a creationist organization in the U.S.* Arta Industrial Group in Iran...
.
On the methodological side, counterparty risk can be affected by wrong way risk, namely the risk that different risk factor
Risk factor
In epidemiology, a risk factor is a variable associated with an increased risk of disease or infection. Sometimes, determinant is also used, being a variable associated with either increased or decreased risk.-Correlation vs causation:...
s be correlated in the most harmful direction. Including correlation between the portfolio risk factors and the counterparty default into the methodology
Methodology
Methodology is generally a guideline for solving a problem, with specificcomponents such as phases, tasks, methods, techniques and tools . It can be defined also as follows:...
is not trivial, see for example Brigo and Pallavicini[4]