Efficient Computation of Exposure Profiles on Real-World and Risk-Neutral Scenarios for Bermudan Swaptions

28 Pages Posted: 7 Jun 2016 Last revised: 4 Jul 2016

See all articles by Qian Feng

Qian Feng

Center for Mathematics and Computer Science (CWI)

Shashi Jain

Indian Institute of Science (IISc) - Deptartment of Management Studies

Patrik Karlsson

drkarlsson.com

Drona Kandhai

University of Amsterdam; ING Bank - Netherlands Office

Cornelis W. Oosterlee

Utrecht University - Faculty of Science

Date Written: July 4, 2016

Abstract

This paper presents a computationally efficient technique for the computation of exposure distributions at any future time under the risk-neutral and some observed real-world probability measures, needed for computation of credit valuation adjustment (CVA) and potential future exposure (PFE). In particular, we present a valuation framework for Bermudan swaptions. The essential idea is to approximate the required value function via a set of risk-neutral scenarios and use this approximated value function on the set of observed real-world scenarios. This technique significantly improves the computational efficiency by avoiding nested Monte Carlo simulation and by using only basic methods such as regression. We demonstrate the benefits of this technique by computing exposure distributions for Bermudan swaptions under the Hull-White and the G2 models.

Keywords: credit valuation adjustment, CVA, Bermudan swaption EE, PFE, risk-neutral measure, real-world measure

JEL Classification: C63

Suggested Citation

Feng, Qian and Jain, Shashi and Karlsson, Patrik and Kandhai, Drona and Oosterlee, Cornelis W., Efficient Computation of Exposure Profiles on Real-World and Risk-Neutral Scenarios for Bermudan Swaptions (July 4, 2016). Available at SSRN: https://ssrn.com/abstract=2790874 or http://dx.doi.org/10.2139/ssrn.2790874

Qian Feng (Contact Author)

Center for Mathematics and Computer Science (CWI) ( email )

P.O. Box 94079
Amsterdam, NL-1090 GB
Netherlands

Shashi Jain

Indian Institute of Science (IISc) - Deptartment of Management Studies ( email )

Indian Institute of Science
Bangalore
India

Patrik Karlsson

drkarlsson.com ( email )

Sweden

Drona Kandhai

University of Amsterdam ( email )

Spui 21
Amsterdam, 1018 WB
Netherlands

ING Bank - Netherlands Office

1102 MG Amsterdam
P.O. Box 1800
1000 BV Amsterdam
Netherlands

Cornelis W. Oosterlee

Utrecht University - Faculty of Science

Vredenburg 138
Utrecht, 3511 BG
Netherlands

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