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Wrong-way risk bounds in counterparty credit risk management

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We study the problem of finding the worst-case joint distribution of a set of risk factors given prescribed multivariate marginals and a non-linear loss function. We show that when the risk measure is conditional value-at-risk (CVaR), and the distributions are discretised, the problem can be conveniently solved using linear programming. The method has applications to any situation where marginals are provided and bounds need to be determined on total portfolio risk. In this paper, we emphasise applications to counterparty credit risk including the assessment of wrong-way risk. A suitable algorithm for counterparty risk measurement of a real portfolio is also presented.
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Keywords: counterparty credit risk, CVaR, Basel III, linear programming, risk management, distributions with given marginals

Document Type: Research Article

Publication date: March 1, 2017

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  • Journal of Risk Management in Financial Institutions is the essential professional and research journal for all those involved in the management of risk at retail and investment banks, investment managers, broker-dealers, hedge funds, exchanges, central banks, financial regulators and depositories, as well as service providers, advisers, researchers and academics. Guided by expert Editors and an eminent Editorial Board, each quarterly 100-page issue does not publish advertising but rather in-depth articles, reviews and applied research by leading professionals and researchers in the field on six key inter-related areas: strategic and business risk, financial risk, including traditional/exotic credit, market and liquidity risks, operational risk, regulatory and legal risks, systemic risk, and sovereign risk.

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