Credit risk in a currency swap

The Basel regulators developed a simple formula to calculate the potential credit exposure on an interest-rate swap, which depends on the time-span of the swap and the creditworthiness of the counterparty. They set the credit risk at 1 for every year the swap has to run, and applied the credit weighting on that 1 in the same way as they did for loans, then knocked off 5o in recognition that swap counterparties are usually more creditworthy than most - a rash assumption, as it turned out. So the...

Too crude too narrow

This was the snag, as far as the regulators were concerned. Most of the models on the market extrapolate data and observations from the world's best-developed markets, predominantly the American bond and equity markets, and apply them to markets where the parameters may be completely different. For example, default rates and loss recovery from American companies, with the benefit of Chapter 11, are likely to be very different from the aggregate default and loss recovery rate in Japan, Germany...