What Is Counterparty Credit Risk?

Counterparty credit risk is the potential for a loss arising from the default event of a counterparty in financial contracts (e.g., derivative contracts and securities borrowing and lending agreements). The credit risk of a counterparty in a depends on various factors, for instance, value of underlying assets, type of netting agreements, and value of collateral.

Understanding counterparty credit risk help financial institutions set the counterparty credit limits and policy, which help mitigate losses when the credit events occur.

Risk managers commonly use various mathematical techniques to quantify and assess counterparty credit risk, including:

• Simulating default events using Copulas
• Estimating transition probabilities of credit ratings
• Pricing of financial instruments (e.g., swaps, options, forwards)

For more on counterpart credit risk, see MATLAB^®, Financial Toolbox™, Financial Instruments Toolbox™, and Risk Management Toolbox™.