dlaw

How Banks Hedge Counterparty Risk

What I want to know - if anyone out there can understand what I'm asking - is why this "meta-hedging" (if you will) does not ultimately reduce to a "martingale".

At some level, the logic seems to be that the more the bank bets the more the bank reduces risk - ad infinitum. But this seems to me to be quite wrong as the frictional costs of unwinding so many trades will be prohibitive - especially in a market without definite and high-speed clearing mechanisms.