Counterparty Risk Subject To ATE

by Richard Zhou of Citigroup

January 14, 2011

Abstract: Credit ATE (Additional Termination Event) clause is a counterparty risk mitigant that allows banks to terminate and close out bilateral derivative contracts if the credit rating of the counterparty falls below the trigger level. Since credit default is often preceded by rating downgrades, credit ATE can significantly reduce the counterparty credit risk by early terminating exposure. However, there is still the risk that counterparty may default without going through severe downgrade. This article presents a practical model for valuating CVA subject to ATE.

JEL Classification: G13.

Keywords: Counterparty Risk, Credit Value Adjustment, Rating Transition, Rating Trigger, Additional Termination Event

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