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| The Pricing Implications of Counterparty Risk for Non-linear Credit Products by Stuart M. Turnbull of the University of Houston October 21, 2005 Abstract: We describe a methodology for deriving the upper and lower profit and loss (P&L) bounds in the presence of counterparty risk that does not rely on either structural or reduced-form credit models. The methodology provides practitioners and regulators with a practical tool to estimate the impact on P&L of the two facets of counterparty risk: failure to perform and mark-to-market exposure. We show that for many applications, the bounds are tight and the creditworthiness of counterparties can have a major impact on the P&L. Keywords: upper and lower loss, P&L, counterparty risk, structural credit models, reduced-form credit models, mark-to-market exposure. Published in: Journal of Credit Risk, Vol. 1, No. 4, (Winter 2005), pp. 3-30. Previously titled: Counterparty Risk and the Effects on P&L This paper is republished as Ch.11 in…
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