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The credit risk components of a swap portfolio

✍ Scribed by Georges Hübner

Publisher
John Wiley and Sons
Year
2003
Tongue
English
Weight
178 KB
Volume
24
Category
Article
ISSN
0270-7314

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✦ Synopsis

Abstract

Thanks to the recent development of analytical pricing models for swaps with bilateral credit risk, a
comprehensive analysis of the dimensions of default risk has become possible. Using the model developed by
Hübner (2001) for IRS and CS, this article investigates the impact of
structural and temporary credit risk changes on swap prices. It emphasizes that large variations in swap values
and sensitivities may exist depending on the sources of credit risk differences between the counterparties. This
phenomenon is stronger for CS because of the exchange of principal and an additional correlation risk that
exhibits a nonnegligible impact on the contract value. The influence of a netting master agreement also can be
analyzed for a wide range of initial contract values and netted notionals. The results confirm the hedging
properties put forward by Duffie and Huang (1996) as a special case, but
clearly show that they cannot be generalized to any netting pattern. Prevailing market conditions are shown to
play a central role in the effectiveness of netting as a hedging device. © 2004 Wiley Periodicals, Inc. Jrl
Fut Mark 24:93–115, 2004

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