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Collateral Risk The collateralized exposure is measured as the valuation difference between the derivative portfolio and collateral assets. In this collateral method, derivative trades and the collateral assets are handled similarly. They are deemed as two “sub-portfolios” with opposite trade direction. Their future value distributions are calculated under the same Monte Carlo simulation framework. All risk factors are simulated simultaneously and consistently. This collateral method is built on a mixture of backward and forward looking style. The counterparty exposure is measured on a date when the counterparty is deemed to be in default. This is consistent with the terminology and concept of “Exposure at Default” in CCR. Standing at a reporting time bucket t, the collateral assets has been posted in the past, and the collateralized exposure depends on the “liquidation” value of the derivative portfolio and collateral assets at some future time. When the Bank determines that the counterparty is in default, it will start to negotiate new trades to replace exist derivative portfolio. At the same time, it will take hold the collateral asset and try to sell these assets in the market. The value fluctuations of the portfolio and the collateral asset during their liquidation periods create risk to the Bank. In a CCR model which inherently incorporates the Wrong Way risk, both trades and collateral assets liquidation value need to be calculated conditional on the fact that the counterparty is in default. This collateral method is built on a mixture of backward and forward looking style. The counterparty exposure is measured on a date when the counterparty is deemed to be in default. This is consistent with the terminology and concept of “Exposure at Default” in CCR. Standing at a reporting time bucket t, the collateral assets has been posted in the past, and the collateralized exposure depends on the “liquidation” value of the derivative portfolio and collateral assets at some future time. When the Bank determines that the counterparty is in default, it will start to negotiate new trades to replace exist derivative portfolio. At the same time, it will take hold the collateral asset and try to sell these assets in the market. The value fluctuations of the portfolio and the collateral asset during their liquidation periods create risk to the Bank. In a CCR model which inherently incorporates the Wrong Way risk, both trades and collateral assets liquidation value need to be calculated conditional on the fact that the counterparty is in default. Although our method is logically more consistent with the counterparty exposure definition, it can also be changed by “shifting” the exposure calculation time t along the timeline. If the time t is set at the end of the liquidation (or closeout) period, then we have a backward looking model. Or if t is set at the beginning of the settlement period, we will have a forward looking model.
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