The link between market risk and credit risk depends on the definition of terms, and these terms are not fixed. Market risk refers to the potential factors that can affect the overall value of the investment portfolio.
Generally, these factors can be divided into a commodity, currency and, equity, and interest risks. Credit risk can be defined as all the credit-related risks faced by investors, or just the specific risk of default by the borrower.
According to the definition of credit risk, market risk and credit risk may correspond or maybe an element of credit risk
Market risk refers to the four main components of market risk that may affect the overall value of the investment portfolio. Currency risk is that foreign exchange rates will change in ways that are not beneficial to investors.
Commodity risk means that commodity prices will change in ways that are not conducive to investors. In both cases, there is also the risk of increased price volatility.
This makes, for example, options contracts more unpredictable, which in turn makes them less attractive to investors, which may reduce their market value.
The third type of risk is a stock risk, that is, investments such as prices or volatile stocks will change in ways that are unfavorable to investors. The final risk, interest rate risk, is the change in current interest rates, which may have a negative impact on investors;
for example, if interest rates generally rise, fixed-rate bonds will be less attractive to investors, thereby reducing their resale value. The definition of credit risk is not so clear, which is why the relationship between the market and credit risk is controversial.
One definition is that credit risk refers to all risks of the borrower’s failure to repay the debt as agreed. For certain types of investment, this will have a direct impact on investors.
For example, if a company defaults on bonds, bondholders cannot obtain access to other people, which is a chain reaction; for example, if a mortgage holder’s insurance policy is sold as part of a debt-backed bond, according to the credit risk By definition, market risk and credit risk are two different risks faced by investors.
They will interact to some extent because the rise in default levels will have a ripple effect on all investors in the financial market. But these two risks are not inseparable.
Stock investors will face market risks, but may not be directly exposed to credit risks. In another definition, credit risk refers to all forms of risk faced by investors.
Market risk, therefore, becomes an element of credit risk. In this case, the risk associated with repayment is often referred to as default risk, and default risk is classified as another element of broader credit risk.