Volume 4— Credit Risk Management © Copyright 2002, CCRO. All rights reserved. 15 as negative exposures do not lead to losses when counterparties default. Moreover, losses need to be adjusted for any recovery that can be expected in the event of counterparty default. Although it is a best practice, simulating the loss distribution can present a formidable challenge. Given this, some companies may elect to use simpler but cruder approximations in describing potential credit losses at the counterparty level in cases where more sophisticated analysis is not possible or not warranted. 3.0 Credit Value at Risk (CVaR) Graphically, the loss distribution can be illustrated as shown in Figure 2. Figure 2. Loss Distribution In the above diagram, 95% of the calculated losses are less than the P95 loss whereas the weighted average of all calculated losses is given by the expected loss. The unexpected loss, or CVaR, is the difference between the potential loss at a given confidence level (95% in this case) and the expected loss over a given time horizon (for which potential exposure was calculated). The above definition of CVaR is consistent with that detailed in Jorion’s Financial Risk Manager Handbook 2001-2002. However, there is currently no consensus in the industry as to an official definition of CVaR. For example, CVaR is sometimes defined as the entire P95 loss, without regard to the expected loss. In still other cases, the term CVaR has been used to describe the one-day change at some confidence level in the expected loss of the portfolio, as opposed to the simulated actual losses over a longer time horizon. Adding to the lack of consensus around the definition of CVaR, there has been some confusion about the appropriateness of CVaR as an indicator of credit risk in the way that VaR is used as an indicator of market risk. In future work, the CCRO will endeavor to clarify the definition, calculation, and uses of CVaR as a credit risk metric. 4.0 Implications for Credit Charges, Credit Reserves, and Credit Capital Frequency 95% 5% Credit Loss ($) P95 Loss Expected Loss CVaR or Unexpected Loss