hedging counterparty risk with credit derivatives

[Marco.Musci]

Hi all,

I have some doubt regarding this part in Gregory, chapter 4:

"Hedging: Hedging counterparty risk with instruments such as credit default swaps (CDSs) aims to protect against potential default events and adverse credit spread movements.
o Hedging creates operational risk and additional market risk through the mark-to-market (MTM) volatility of the hedging instruments. Taking certain types of collateral can create wrong-way risk. Hedging may lead to systemic risk through feedback effects."

I would like to ask:

1) how can we use credit derivatives to hedge counterparty risk, considered that the exposure will fluctuate through time?
2) what are the feedback effects?

Thank you in advance,
Marco.

 

[Nicole Seaman]

Hi all,

I have some doubt regarding this part in Gregory, chapter 4:

"Hedging: Hedging counterparty risk with instruments such as credit default swaps (CDSs) aims to protect against potential default events and adverse credit spread movements.
o Hedging creates operational risk and additional market risk through the mark-to-market (MTM) volatility of the hedging instruments. Taking certain types of collateral can create wrong-way risk. Hedging may lead to systemic risk through feedback effects."

I would like to ask:

1) how can we use credit derivatives to hedge counterparty risk, considered that the exposure will fluctuate through time?
2) what are the feedback effects?

Thank you in advance,
Marco.

Hello @Marco.Musci

I'm sure someone else in the forum can give you more specific answers, but if you do a quick search in the forum for "hedging counterparty risk with credit derivatives", there are many forum threads that discuss these concepts. You may find your answer within these threads without having to wait for someone to answer your questions Here are a few threads that came up when I did the search:

• https://forum.bionicturtle.com/threads/how-to-hedge-total-return-swap-using-cds.5946/
• https://forum.bionicturtle.com/threads/p2-t6-407-credit-exposure-gregory.7704/
• https://forum.bionicturtle.com/threads/cds-bond-basis-factors-confusing-impact.10284/
• https://forum.bionicturtle.com/thre...al-return-swaps-topic-review.6217/#post-35586

I hope this helps a bit!

Nicole

 

[Marco.Musci]

Thank you @Nicole Seaman I will have a look.