Efficient Estimation of Sensitivities for Counterparty Credit Risk with the Finite Difference Monte-Carlo Method
25 Pages Posted: 19 Dec 2014
There are 2 versions of this paper
Efficient Estimation of Sensitivities for Counterparty Credit Risk with the Finite Difference Monte-Carlo Method
Efficient Estimation of Sensitivities for Counterparty Credit Risk with the Finite Difference Monte Carlo Method
Date Written: November 10, 2014
Abstract
According to Basel III, financial institutions have to charge a Credit Valuation Adjustment (CVA) to account for a possible counterparty default. Calculating this measure and its sensitivities is one of the big challenges in risk management. Here we introduce an efficient method for the estimation of CVA and its sensitivities for a portfolio of financial derivatives. We use the Finite Difference Monte-Carlo (FDMC) method to measure exposure profiles and consider the computationally challenging case of FX barrier options in the context of the Black-Scholes as well as the Heston Stochastic Volatility model for a wide range of parameters. Our results show that FDMC is an accurate method compared to the semi-analytic COS method and has as an advantage that it can compute multiple options on one grid, which paves the way for real portfolio level risk analysis.
Keywords: Expected Exposure, CVA, Potential Future Exposure, sensitivities, barrier options, Heston, numerical computation, finite differences, Portfolio
JEL Classification: C63, G12
Suggested Citation: Suggested Citation