ravishankar80
New Member
Hi David,
I do not understand the concept of haircuts very well? Can you explain that ?
Regards
Ravi
I do not understand the concept of haircuts very well? Can you explain that ?
Regards
Ravi
Haircut
- Thread starter ravishankar80
- Start date
Hi Ravi,
Might best be understood where we see the haircut in advanced (comprehensive) CRM approach in Basel 2. In this advanced approach, an exposure is reduced by its collateral:
E = E*(1+haircut) - C*(1-haircut)
(there is a currency mismatch haircut, but for this, assume exposure and collateral are in the same currency)
So, say my exposure to you is bond, then
E = E[bond]
but that is just my current exposure, there will be some future volatility so i "volatility-adjust" the exposure: i plus it up to account for future uncertainty that can increase my exposure (Did you see the screencast yet on counterparty exposure: the "diffusion" effect creates potential future exposure greater than current exposure). So, I add the haircut:
E = E[bond + haircut]
Now i have a volatility-adjusted exposure (i.e., current plus something for possibility of increase.
But now you post CASH COLLATERAL as a credit risk mitigant (CRM). Now my exposure is:
E = E[bond + haircut] - C[cash as collateral]
In fact, cash has a haircut value = 0, so this is
E = E[bond + haircut] - C[1 - 0]
But say, instead you post a convertible bond as collateral. Now, I worry about two volatilities vis a vis current exposure: 1. the bond exposure can go up in value and 2. the collateral can go down in value
(btw, if they are negatively correlated, exposure and collateral, we can call this WRONG-WAY EXPOSURE)
To volatility-adjust the collateral, now I have:
E = E[bond + haircut] - C[1 - haircut]
So, hopefully you see, i am adding the first and subtracting the second haircut because that reflects a "getting worse" situation...
if you'd like a little more, Jyothi and I had a thread on this last year
David
Might best be understood where we see the haircut in advanced (comprehensive) CRM approach in Basel 2. In this advanced approach, an exposure is reduced by its collateral:
E = E*(1+haircut) - C*(1-haircut)
(there is a currency mismatch haircut, but for this, assume exposure and collateral are in the same currency)
So, say my exposure to you is bond, then
E = E[bond]
but that is just my current exposure, there will be some future volatility so i "volatility-adjust" the exposure: i plus it up to account for future uncertainty that can increase my exposure (Did you see the screencast yet on counterparty exposure: the "diffusion" effect creates potential future exposure greater than current exposure). So, I add the haircut:
E = E[bond + haircut]
Now i have a volatility-adjusted exposure (i.e., current plus something for possibility of increase.
But now you post CASH COLLATERAL as a credit risk mitigant (CRM). Now my exposure is:
E = E[bond + haircut] - C[cash as collateral]
In fact, cash has a haircut value = 0, so this is
E = E[bond + haircut] - C[1 - 0]
But say, instead you post a convertible bond as collateral. Now, I worry about two volatilities vis a vis current exposure: 1. the bond exposure can go up in value and 2. the collateral can go down in value
(btw, if they are negatively correlated, exposure and collateral, we can call this WRONG-WAY EXPOSURE)
To volatility-adjust the collateral, now I have:
E = E[bond + haircut] - C[1 - haircut]
So, hopefully you see, i am adding the first and subtracting the second haircut because that reflects a "getting worse" situation...
if you'd like a little more, Jyothi and I had a thread on this last year
David
