Counterparty Exposure Models
Collection of models that are used to measure and manage the credit risk associated with Off-Balance-Sheet-Instruments.
Fundamentally those are market risk models aiming to obtain position values at future dates (as in VaR market risk approaches), but conditioning on adverse credit scenarios.
Issues and Challenges
- One of the key problems with exposure models is that market variability is not conditioned on a counterparty default. This is particularly relevant in cases of so called Wrong Way Risk, where the event of default coincides with an unfavorable for the counterparty move on the underlying market, which further increases the Exposure At Default