I would appreciate if someone can clarify for me why Credit risk is Financial risk but settlement risk is non-financial risk? Both seem to be counterparty risk to me.
settlement risk - risk of counterparty going bankrupt when the settlement is being made to them. essentially because they go bankrupt - any payments made to them - would go over to the other creditors. If the bankruptcy had happened before - you (payer) would not have owed anything. This payment would have been pardoned. so it is a non-financial risk.
If you had owed money, and were unable to pay - it is a financial risk for you - which is credit risk.
Basically settlement risk is the risk of payments being frozen in court because a counterparty takes a dive. Credit risk is a counterparty defaulting.
Read more here.
http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91319086
Thanks for the clarification.
Among the risks , credit risk could be modeled . The market after all prices in credit risk in transactions . For example the small firm premium increases during market crises. Also weak , emerging economies are hit hardest during flights-to-safety events . In other words when an investor prices the transaction , credit is priced into it. So it is a financial , measurable risk.
Settlement risk is hard to model as the underlying event is rare and its outcome is more uncertai when it does occur. Usually involves litigation and judges deciding outcomes , not markets . So it is non-financial risk
Makes sense, I see the difference now.
What about model and tail risk then? Why are these not financial risks? I’m no scientist, but you hear such things as… we were measuring so and so and we got the following result. The chances that this is an anomoly of the model is say 1 billionth of a percent, so we’re confident that what we observed is consistent with our models… at least something of this nature. Or engineering… the chance of failure is one in a billion. All this is measurable and related to models and tails.