Section I: Introduction
This first section covers introductory aspects in relation to counterparty credit risk and CVA and is aimed at providing the background for readers new to the area.
Chapter 1 sets the scene and explains the emergence of counterparty credit risk, especially in relation to the global financial crisis that began in 2007. This discusses the basic problems such as the “too big to fail” phenomenon and the complexities of the activities of banks and the OTC derivative markets. The role of regulation is also introduced.
Some of the important background concepts are covered in Chapter 2. This discusses financial risk management in general, outlining the different types of financial risk and their relationship to counterparty risk. The important concept of value-at-risk (VAR) is also defined and explained with the dangers of VAR carefully noted. This chapter discusses OTC (over-the-counter) derivatives markets and their benefits and drawbacks, paying particular attention to credit derivative instruments which allow hedging of counterparty risk but contain significant counterparty risk themselves. The mitigation of counterparty risk, in particular in relation to central clearing, is introduced also.
Chapter 3 is dedicated to defining counterparty risk. This includes outlining the underlying products for which counterparty risk is relevant and discussing the development and nature of exchange traded and OTC derivative markets. The different players in the counterparty ...
