Counterparty Credit Risk Research

In recent30years, large commercial banks have been in the process oftransforming from traditional deposit and lending commercial banks to universalcommercial banks. To enhance their market competitiveness, large commercial bankshave being devoted to design a large number of financial derivatives in order to meetdifferent customers’ investing or financing needs. With the deepening of financialinnovation, on one hand, the society as a whole benefits from the efficiency ofresource allocation; on the other hand, the infectivity of the entire financial systemrisk also increases, and counterparty credit risk faced by financial institutions is moreand more complicated. This is an important cause of why recent financial crises haveshown strong infectiousness of credit risk event. During2008financial crisis, theBasel Committee had been repeatedly criticized for its loopholes on the supervision ofcounterparty credit risk. So Basel Committee focused on improving counterpartycredit risk regulation in its newly released third edition of the Basel Accord. TheAccord explicitly requires commercial banks to calculate risk-weighted assets forcredit valuation adjustment and default risk-weighted assets for counterparty credit,and include them into market risk-weighted asset and credit risk-weighted assetsrespectively.This thesis based on the practice of the domestic financial market, conducts acomprehensive empirical study of counterparty credit risk, and using copula functionanalyzes the influences of the correlation between different market risk factors to theexposure to counterparty credit risk. This thesis firstly summarizes the asset pricingtheory on financial derivatives and stochastic models of asset prices and interest rates,and suggests using geometric Brownian motion model and principal componentsanalysis model in the simulation of the exchange rate of U.S. dollar against RMB andinterest rate of U.S. dollar and RMB. Then this thesis makes a comprehensivesummary of the theory and practice of counterparty credit risk, including itscharacteristics, risk mitigation measures, wrong-way risk, the measurement ofcounterparty credit risk exposure, the measurement of credit valuation adjustment anddefault risk-weighted assets for counterparty credit risk and counterparty credit risklimits, With an emphasis on the study of the nature of the copula function, the measurement of linear correlation and copula function correlation, the measurementof copula function tail correlation, construction and estimates of the copula function,the selection and evaluation of the copula function as well as the comparison of thedifferent copula functions. Finally, the thesis conducts three empirical studies. Thefirst study, with demonstration of the most common financial products of foreignexchange forwards and interest rate swaps in the domestic financial market, uses thecurrent exposure method and internal models method separately in measuring thecounterparty credit risk exposure, uses the standardised method and bond equivalentmethod separately in measuring risk-weighted assets for credit valuation adjustment,and uses the standardised method and the IRB measurement separately in measuringdefault risk-weighted assets for counterparty credit risk. The second study poses anempirical analysis on the effects of two types of risk mitigation measures--nettingagreements and collateral agreements--on the counterparty credit risk. The third studyanalyzes the correlation of the exchange rate of U.S. dollar against RMB and the U.S.dollar interest rate, and of the exchange rate of U.S. dollar against RMB and RMBinterest rate, based on Gaussian Copula, t Copula, Gumbel Copula, Clayton Copulaand Frank Copula. The study also measures the expected exposure of the entireportfolio, the credit valuation adjustment and default risk-weighted assets forcounterparty credit risk when correlation exists and not respectively.