Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge for Global Financial Markets, 2nd Edition

8.4 Understanding the Impact of Netting on Exposure

We now consider in more depth the impact of netting on exposure. Since netting allows the future values of trades to offset one another, then the aggregate effect of all trades must be considered. As we shall see, there are several different aspects to contemplate before understanding the full netting impact on overall exposure with respect to a particular counterparty. In the next section, we will consider the impact of collateral on exposure. In both cases, we will describe the general points to consider before analysing netting and collateral from a more detailed and quantitative view in the next chapter.

8.4.1 The Impact of Netting on Future Exposure

We illustrate the impact of netting on exposure in Figure 8.21 with exactly opposite transactions. When there is no legal agreement to allow netting then exposures must be considered additive. This means that the positions do not offset one another. With netting allowable (and enforceable), one can add values at the netting set level before calculating the exposure and therefore the profiles shown give a zero exposure at all points in the future.

Figure 8.21 Illustration of the impact of netting on exposure.

8.4.2 Netting and the Impact of Correlation

When considering the netting benefit of two or more trades, the most obvious consideration is the correlation between the future ...