The risk that exposure to a counterparty rises just as its credit quality falls. It makes losses on default worse than independent estimates suggest.
Where you will meet it
Wrong-way risk comes up in 23 learning outcome notes across the FRM syllabus.
A few of them:
Introduction to Derivatives FRM Part I · Financial markets and products
“Wrong-way risk occurs when exposure rises as the counterparty's credit quality worsens.”
The Building Blocks of Risk Management FRM Part I · Foundations of risk management
“Wrong-way risk occurs when exposure to a counterparty is largest just when its default probability is highest.”
Measuring Credit Risk FRM Part I · Valuation and risk models
“Wrong-way risk arises when exposure tends to be high just when the counterparty is likely to default.”
Credit Risk FRM Part II · Credit risk measurement and management
“Each mitigant has residual risks: legal enforceability, collateral volatility and delay, and wrong-way risk when collateral is tied to the counterparty.”
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