# 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. Source: https://learn.tradelabsai.com/portfolio/counterparty-risk/ Track: Portfolio and Performance · Level: Advanced · Updated: 2026-10-03 Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice. Cite as: TradeLabs Learn, "Market, Credit and Counterparty Risk", https://learn.tradelabsai.com/portfolio/counterparty-risk/ 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)](https://learn.tradelabsai.com/portfolio/value-at-risk/) | | Credit risk | A borrower or bond issuer defaults | A company misses bond payments | [Default Probability and Recovery Rate](https://learn.tradelabsai.com/bonds-credit/default-probability/) | | 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](https://learn.tradelabsai.com/portfolio/risk-limits/) and [Hedging](https://learn.tradelabsai.com/markets/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) ``` **Example: Expected loss on a bond holding** An investor holds $100,000 of a company's bonds. The estimated annual default probability is 2%, and if default happens, bondholders typically recover 40% of face value. The expected annual loss is 2% times $100,000 times (1 minus 0.40), which is $1,200. The bond's extra yield over government bonds, its credit spread, should at least compensate for that expected loss plus a premium for uncertainty. See [Credit Spreads](https://learn.tradelabsai.com/bonds-credit/credit-spreads/) and [Credit Ratings](https://learn.tradelabsai.com/bonds-credit/credit-ratings/). ## 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](https://learn.tradelabsai.com/market-structure/clearing-houses/) | | Over the counter derivatives | Dealer bank | Collateral agreements, central clearing for many swaps. See [OTC Markets](https://learn.tradelabsai.com/market-structure/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](https://learn.tradelabsai.com/crypto/cex-vs-dex/) | | CFD and forex brokers | Broker as counterparty | Regulation, segregated client funds where required. See [What Is a CFD?](https://learn.tradelabsai.com/markets/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](https://learn.tradelabsai.com/history/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](https://learn.tradelabsai.com/history/archegos-capital/) | ## Managing counterparty risk 1. **Choose regulated, well capitalised brokers** and understand how client assets are protected. See [How to Choose a Broker](https://learn.tradelabsai.com/industry/how-to-choose-a-broker/). 2. **Spread assets** across institutions when balances are large. 3. **Prefer centrally cleared products** where possible. 4. **Do not leave excess cash** on exchanges or with brokers you would not trust in a crisis. 5. **Use collateral and netting agreements** in OTC trading. 6. **Monitor warning signs:** falling share prices, widening credit default swap spreads, withdrawal delays. See [Credit Default Swaps (CDS)](https://learn.tradelabsai.com/bonds-credit/credit-default-swaps/). ## 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](https://learn.tradelabsai.com/portfolio/liquidity-risk/). ## Continue learning - Next lesson: [Liquidity Risk](https://learn.tradelabsai.com/portfolio/liquidity-risk/) - Previous lesson: [Stress Testing and Scenario Analysis](https://learn.tradelabsai.com/portfolio/stress-testing/) - Related: [Stress Testing and Scenario Analysis](https://learn.tradelabsai.com/portfolio/stress-testing/): Stress testing asks how a portfolio would fare in extreme but plausible events. Learn historical and hypothetical scenarios and reverse stress tests. - Related: [Clearing Houses and Central Counterparties](https://learn.tradelabsai.com/market-structure/clearing-houses/): Clearing houses stand between buyers and sellers so every trade is honoured. Learn how central counterparties work, margin, default funds and why they matter. - Related: [Credit Default Swaps (CDS)](https://learn.tradelabsai.com/bonds-credit/credit-default-swaps/): A credit default swap is insurance like protection against a borrower defaulting. Learn how CDS work, spreads and upfront pricing, credit events, uses and risks. - Related: [Default Probability and Recovery Rate](https://learn.tradelabsai.com/bonds-credit/default-probability/): Default probability is the chance a borrower fails to pay. Learn historical default rates, probabilities implied by spreads, the Merton model and recovery rates. - Related: [Liquidity Risk](https://learn.tradelabsai.com/portfolio/liquidity-risk/): Liquidity 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. - Related: [Systemic Risk](https://learn.tradelabsai.com/portfolio/systemic-risk/): Systemic risk is the danger that problems at one firm or market spread through the whole financial system. Learn its channels, past examples and what traders can do.