Interest Rate Modeling And Counterparty Credit Risk Measurement For Interest Rate Derivatives

Counterparty risk is the risk that the other party in an agreement will de-fault. Banks are the main participants in the OTC derivatives market. Banks engaged in the derivatives business will have to consider Counterparty Credit Risk. After the U.S. sub-mortgage crisis, the management of the counter-party credit risk of OTC derivatives is very important for financial institutions."Basel Ⅲ" puts forward new regulatory capital requirements for counterparty credit risk expected mark-to-market loss of OTC derivative transactions.In this paper,we devote to analyzing counterparty credit risk for interest rate derivatives.Firstly, we introduce the principal methods for measuring replacement risk,containing EAD(exposure at risk),CAR(current average risk), CVAR(credit value at risk), netting and margin calls. CVAR is an indicator of extreme losses.CAR and CVAR is very important indicators for measuring counter-party credit risk.Secondly, we devote to the method of modeling the dynamics of the Zero Coupon Curve.In order to construct the Zero Coupon Yield Curve, we present the rates with eight maturities.The diffusion model is a multi-factor mean re-verting model that takes into account the correlation inter maturity of the yield curve for each currency. Some currencies are diffused individually, inde-pendent of others, on the other hand, for the popular currencies which SG has more positions, containing17currencies, we diffuse simultaneously. We pro-vide the bootstrapping method to construct the term structure of zero-coupon rate from historical data.To calibrate the parameters of the model, we propose two methods, the trace minimization method and the double diagonalisation method, in our department, we prefer to the double diagonalisation method. The minimization method is devoted to fastening the long-term structure of the yield curve.The double diagonalisation method starts from the short-term vari-ance and covariance matrix, its objective is to simplify the calibrated volatility. These two methods are widely used by different departments.Thirdly, we focus on interest rate swap.The interest rate swap market is one of the most important fixed-income markets in trading and hedging interest rate. In this section, we introduce in detail the theory of the interest rate swap(IRS), then we study the impact of different parameters on profiles of CAR, CVAR of MTF(mark To future)value.Fouthly, we examine currency interest rate swap(CIRS). Different from the interest rate swap, currency interest rate swaps are in different currencies involving the exchange of principal amounts at inception and at maturity. There are three types, fixed for fixed, fixed for floating, floating for floating currency swap.We analyze the relative profile of CAR and CVAR. In order to reduce the possibility of the default, we incorporate the margin calls.The theoretical valuation and dynamic risk measurement framework in this paper can be useful in tracking the risk exposure in a changing market.