Wrong Way Risk
Wrong Way Risk is an important topic in the CVA context and needs particular attention. Wrong Way Risks means an adverse correlation between exposure and probability of default of a certain counterparty.
Specific or general?
One distinguishes between specific and general Wrong Way Risk. The first means a risk that is caused by the structure of a certain transaction. E.g. a trade could be collateralised by bonds or even shares of the counterparty. In case of default this collateral would lose all of its value. Such cases arise especially after acquisitions or fusions.
General Wrong Way Risk is caused not by the trade itself, but by dependencies on macro-economic factors. On the one hand a rising exchange rate could make a default of a counterparty more probable – and on the other hand increase your exposure to this specific counterparty. Concentration risk should be named in this context too.
Wrong Way Risk and CVA
CVA is calculated as the product of PD, LGD and exposure. Usually these values are determined separately and thus implicetly considered as uncorrelated. This leads to a systematic underestimation of your counterparty risk in case of Wrong Way Risk. For this reason Basel III claims for special observation and methods for the identification of Wrong Way Risk.
How to secure yourself?
Only a well maintained database of counterparties and a thorough analysis of your business relationships together with the present market conditions does give security against Wrong Way Risk.
For the necessary analyses we lend you our support.
We offer technical expertise to track the threat of specific Wrong Way Risk automatically. Our deep knowledge of the industry helps you to identify general Wrong Way Risk.
Protect yourself from hidden risks! Make use of our expertise. If you have further questions do not hesitate to contact us via E-Mail or our contact form.