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CREDIT DERIVATIVES AND RISK MANAGEMENT IN BANKING

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Author(s): Jun-xun DAI

Journal: Management Science and Engineering
ISSN 1913-0341

Volume: 2;
Issue: 4;
Start page: 1;
Date: 2008;
Original page

ABSTRACT
The striking growth of credit derivatives suggests that market participants find them to be useful tools for risk management. This paper illustrate the value of credit derivatives with two examples. A commercial bank can use credit derivatives to manage the risk of its loan portfolio. However, credit derivatives pose risk management challenges of their own. This paper discuss five of these challenges. Credit derivatives can transform credit risk in intricate ways that may not be easy to understand. They can create counterparty credit risk that itself must be managed. Complex credit derivatives rely on complex models, leading to model risk. The settlement of a credit derivative contract following a default can have its own complications, creating settlement risk. For the credit derivatives market to continue its rapid growth, commercial banks must meet these risk management challenges. Key words: Credit risk, Credit Derivative, Counterparty risk
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