Keywords: Counterparty risk, collateral, margin, derivatives
Abstract: Firms active in OTC derivative markets increasingly use margin agreements to
reduce counterparty credit risk. Making several simplifying assumptions, I use both a quasi-
analytic approach and a simulation approach to quantify how margining reduces counterparty
credit exposure. Margining reduces counterparty credit exposure by over 80 percent, using
baseline parameter assumptions. I show how expected positive exposure (EPE) depends on
key terms of the margin agreement and the current mark-to-market value of the portfolio of
contracts with the counterparty. I also discuss a possible shortcut that could be used by firms
that can model EPE without margin but cannot achieve the higher level of sophistication
needed to model EPE with margin.
Full paper (587 KB PDF)
Home | FEDS | List of 2005 FEDS papers
To comment on this site, please fill out our feedback form.
Last update: November 4, 2005