Financial Analysts Journal · 1994 · 218 citations · 0 references
ManagementRisk ManagementFinancial EconomicsFinancial Risk ManagementRisk AssessmentCounterparty Credit RiskCredit RiskDerivatives Default ManagementInterest Rate RiskMarket RiskRisk ModelingCounterparty Default ModelingCounterparty Default RiskCredit ConditionsDefault ProbabilityDefault Risk AnalysisDefault Risk ModelingSwap Risk ManagementYield Curve Risk
The expanding interest‑rate swap market has heightened the need to assess default risk, prompting participants to mitigate it through counterparty selection or negotiated risk pricing. The study develops a model that jointly evaluates the probability of counterparty default and the resulting cost to the solvent party. The model incorporates swap parties' credit conditions and the shape and volatility of the yield curve. The model helps to establish the correct level for a swap between risky parties.
With the growth in the market for interest rate swaps has come a growing need to understand the potential default risks of these instruments. In general, swap participants can deal with default risk by seeking to mitigate it (by dealing only with AAA-rated counterparties, for example). Alternatively, potential counterparties can attempt to come to some agreement about the degree of default risk and use that knowledge to price their positions. A model of swap default risk evaluates jointly the probability of the swap counterparty defaulting and the cost (or impact) of the default for the solvent party. The model helps to establish the correct level for a swap between risky (or potentially risky) parties. The key considerations are the swap parties' credit conditions and the shape and volatility of the yield curve.