Current Exposure Methodology (CEM) is a regulatory framework for calculating the credit risk exposure of derivatives contracts, typically used by banks to determine capital requirements. It measures the potential loss if a counterparty defaults today, based on the current market value of the contract plus an add-on for potential future exposure. In crypto, this methodology can be adapted to assess counterparty risk in decentralized finance (DeFi) lending or options protocols.
Mechanism
The mechanism involves two primary components: replacing the derivatives contract with its current mark-to-market value (if positive) and adding a fixed percentage of the notional principal to account for potential increases in value over the remaining life of the contract. This add-on factor varies by asset class and residual maturity. For crypto derivatives, determining the add-on factor would require specific considerations for digital asset volatility and market liquidity.
Methodology
This methodology provides a simplified yet conservative approach to credit risk measurement, aiming to ensure institutions hold adequate capital against potential counterparty defaults. Its application in the crypto institutional options trading space can offer a structured way to quantify and manage the credit exposure associated with complex digital asset derivatives, enhancing risk management practices where traditional clearinghouses are absent.
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