Leveraged wrong-way risk
A model to assess the exposure to leveraged and collateralised counterparties is presented
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Matthias Arnsdorf introduces a simple model of the credit exposure to leveraged and collateralised counterparties. Wrong-way risk is captured by linking the counterparty default probability directly to changes in the portfolio value. This applies to leveraged firms, such as hedge funds, where large collateral calls can be the driver of default. The model is able to reproduce the large losses observed in recent events, which were unexpected based on typical
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