Chapter 7. Credit Risk Management

This chapter introduces some useful tools for credit risk management. Credit risk is the distribution of the financial losses due to unexpected changes in the credit quality of a counterparty in a financial agreement (Giesecke 2004). Several tools and industrial solutions were developed for managing credit risk. In accordance with the literature, one may consider credit risk as the default risk, downgrade risk, or counterparty risk. In most cases, the default risk is related directly to the risk of non-performance of a claim or credit. In contrast, downgrade risk arises when the price of a bond declines due to its worsening credit rating without any realized credit event. Counterparty risk means the risk when the counterparty of a contract does not meet the contractual obligations. However, the contractual or regulatory definition of a credit event can usually be wider than just a missed payment. The modeling end estimation of the possibility of default...