Exposure under systemic impact

Wrong-way risk (WWR) behaves differently for exposures to systemically important counterparties because their default has the potential to move financial markets before the close-out. Michael Pykhtin and Alexander Sokol show how the traditional exposure simulation framework can be adapted to account for this systemic WWR. They illustrate how the model can be calibrated by using market credit default swap spreads and historical defaults – including those of Russia, Argentina and Lehman Brothers

The financial crisis of 2007–2009 has emphasised the importance of measuring and managing counterparty credit risk (CCR) for all market participants. The collapse of Bear Stearns, Lehman Brothers and Wachovia showed that even the largest financial institutions can fail. In particular the Lehman Brothers’ default illustrated that failure of a large financial institution can disrupt world markets and adversely affect the world economy. In the wake of the crisis, the Basel Committee on Banking