Can anyone explain what credit at risk means? What is the difference between credit at risk and value at risk? Thanks.
VAR tells you the value of the minimum loss that can occur x% of the time (e.g. loss of at least $1,000, 5% of the time or once a month given that there 20 trading days in a month) Credit at risk is a related concept to VAR, but it is concerned with losses of your potential gain. Say you entered in a swap, and in a week the value of your swap position is $100, that $100 is potential credit risk (since if position is settled tomorrow, and counterparty defaults, you get nothing). Credit at risk tries to measure the magnitude of such a loss with given probability of it happening. Credit at risk, however, is not as easy as VAR to calculate.
and CAR focuses on the upper tail while VAR focuses on the bottom tail.
Good point 3rd & Long. Credit At Risk focuses on the Upper Tail b/c its when you have a “Gain” on a derivative you have potential and/or current credit risk b/c the opposite party might not pay out. If you had a Loss on teh position you have no credit risk b/c you owe the other party.
I understand that credit at risk can only appear in the exam when talking about the value of an existing swap or fwd, etc, with a value different than zero, right? what about bonds? can credit at risk be used? and options? In some examples they say that current credit risk equals the current premium (which by definition is the pv of expected result). But calculating “credit at risk” of a long position in an option… does it make sense? thx
In credit risk, we r trying to measure the quantum (Money) of the loss if the other party defaults when ur IN THE MONEY. Since, the probability of the other party defaulting on his/her payments rises as ur paper profits increase, so we look at the upper tail, which means if my returns are above the mean / 0, I’m carrying a higher probability of risk that the other party will default. so more u move to the right on the distribution, the more the credit risk the u r facing. another perspective is that, both VAR and Credit risk focuses on the bottom tail depending on how one looks at it. in VAR Case its ur perspective, and in Credit risk case its the counterparty’s perspective…
What if we hold a bond portfolio, which will fall when interest rates rise - this is the case of negative return. But at the same time credit risk will most likely rise!!! The same is true for currency swaps … Any ideas? I also cant get why Schweser talking about MBS whose value will be capped when interest rates will fall use it as an argument why we need to concentrate on the upper tale?
credit risk is present when the delivery / settlement / payment is to be made at a future date. In case of a bond portfolio, there is only default risk and other risks - no credit risk as you already have the bonds in ur portfolio
manjunath.gaddi, Credit risk is a risk of changing credit spreads, it presents each time your have a debt instrument in the portfolio. Also, Schweser mentioned MBS-related example (which i cant understand what it was done for) in the context of credit VAR so it adds more to the confusion…
I am not aware of the reference of this to the study material as i havent started anything. So, here’s a practical explanation. VAR : the notional at risk due all types of risk be it credit, IR, FX, etc - remember it is not the sum of all of them, as these risks are correlated ( it can be some nth order approx based on the model being used to simulate the path of the securities in the portfolio) Credit Risk : the notional at risk calculated based on the probability of defaults and MTM losses on the spreads. ~A.D.