Explanation:
Wrong-way risk (WWR) occurs when exposure to a counterparty is positively correlated with the counterparty's probability of default. For central counterparties (CCPs), this risk arises because:
CCPs disassociate credit quality and exposure: CCPs typically accept collateral based on standardized haircuts rather than the specific credit quality of individual counterparties. This means they may hold insufficient collateral when a counterparty's credit quality deteriorates.
Systemic risk concerns: During periods of market stress, multiple large dealers may face simultaneous defaults, creating concentrated exposure for CCPs.
Collateral valuation issues: The value of posted collateral may decline precisely when counterparty credit risk increases, exacerbating WWR.
Option C correctly identifies that CCPs are at risk of WWR due to the disassociation between credit quality and exposure management. The other options are incorrect:
Ultimate access to all questions.
Which of the following is true about the impact of wrong-way risk (WWR) on central counterparties (CCPs)?
A
Larger dealers represent right-way risk.
B
CCPs are somewhat immune to wrong-way risk.
C
CCPs are at risk of wrong-way risk (WWR) because they disassociate credit quality and Exposure.
D
Their method of collateral acceptance promotes right-way risk with respect to posted Collateral.
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