Market, Credit and Counterparty Risk Explained

Market, Credit and Counterparty Risk

Learn the difference between market risk, credit risk and counterparty risk, how each is measured and managed, and real cases from Lehman Brothers to FTX.

Advanced3 min readUpdated 3 Oct 2026

Lesson 30 of 34

Financial risk comes in several forms. Market risk is the chance of losing money because prices move. Credit risk is the chance that a borrower fails to repay. Counterparty risk is a specific kind of credit risk: the chance that the other side of a trade, or the firm holding your assets, fails before meeting its obligations. Traders tend to focus on market risk, but counterparty failures, from Lehman Brothers in 2008 to the FTX exchange in 2022, have wiped out people who were right about the market.

The three risks#

Risk	Source	Example	Lesson
Market risk	Price movements in stocks, rates, currencies, commodities	A stock falls 20%	Value at Risk (VaR)
Credit risk	A borrower or bond issuer defaults	A company misses bond payments	Default Probability and Recovery Rate
Counterparty risk	The other party to a contract or the holder of your assets fails	A broker or swap dealer goes bankrupt	This lesson

Market risk#

Measured with volatility, beta, VaR, expected shortfall and stress tests, and managed with position sizing, diversification, hedging and limits. See Risk, Position, Loss and Drawdown Limits and Hedging.

Credit risk#

Credit risk depends on the probability of default, the exposure at the time of default and how much is recovered.

Expected credit loss = Probability of default × Exposure at default × (1 - Recovery rate)

Counterparty risk in practice#

Situation	Counterparty	Protection
Exchange traded futures and options	Clearing house	Margin, default funds, mutualised losses. See Clearing Houses and Central Counterparties
Over the counter derivatives	Dealer bank	Collateral agreements, central clearing for many swaps. See OTC Markets
Stock brokerage accounts	Broker	Segregation rules and, in the US, SIPC coverage for missing securities up to set limits
Crypto exchanges	Exchange	Often little formal protection; self custody for long term holdings. See Centralized vs Decentralized Exchanges
CFD and forex brokers	Broker as counterparty	Regulation, segregated client funds where required. See What Is a CFD?

Lessons from failures#

Event	What happened
Lehman Brothers, 2008	Its bankruptcy froze client assets and derivative positions worldwide for years. See The 2008 Financial Crisis
MF Global, 2011	The futures broker collapsed with a shortfall in customer funds, later largely recovered
FTX, 2022	The crypto exchange collapsed after customer funds were misused; customers waited years in bankruptcy proceedings
Archegos, 2021	Prime brokers lost billions when the family office could not meet margin calls. See Archegos Capital

Managing counterparty risk#

Choose regulated, well capitalised brokers and understand how client assets are protected. See How to Choose a Broker.
Spread assets across institutions when balances are large.
Prefer centrally cleared products where possible.
Do not leave excess cash on exchanges or with brokers you would not trust in a crisis.
Use collateral and netting agreements in OTC trading.
Monitor warning signs: falling share prices, widening credit default swap spreads, withdrawal delays. See Credit Default Swaps (CDS).

Frequently asked questions#

What is counterparty risk?#

The risk that the other party to a trade or the institution holding your assets fails to meet its obligations.

How is credit risk different from market risk?#

Market risk comes from price movements; credit risk comes from a borrower or issuer failing to pay what it owes.

How do clearing houses reduce counterparty risk?#

They stand between buyers and sellers, collect margin daily and maintain default funds, so one member's failure does not directly hit others.

Next, learn about the risk of not being able to trade when needed in Liquidity Risk.

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Next lessonLiquidity RiskLiquidity risk is the danger of being unable to trade quickly at a fair price, or running short of cash. Learn its two types, how to measure it and controls.