Modeling the Path-Dependency of the Credit Exposure in Vanilla Products

Wilmott Magazine, Issue 84, Pages 56–71, July 2016

13 Pages Posted: 12 Dec 2016 Last revised: 27 Aug 2018

Date Written: July 1, 2016

Abstract

This paper focuses on modeling the scenario path-dependency of the counterparty credit exposure. The purpose of this paper is threefold: (1) to propose a simple method for consistent estimation of pathwise European swaption exercise probability; (2) to discuss accurate pathwise simulation of barrier option exposure; and (3) to present some exact formulas for the calculation of standalone expected positive exposure and potential future exposure for a single-currency vanilla swap, a physically settled European swaption, and a barrier option without Monte Carlo simulation. These exact formulations are of practical importance to computing standalone exposure profiles, exposure model validation, and system benchmarking.

Keywords: Path-Dependent Exposure, Exact Exposure Profile, Swaption Exercise Probability, Barrier Survival Probability

Suggested Citation

Zhou, Richard, Modeling the Path-Dependency of the Credit Exposure in Vanilla Products (July 1, 2016). Wilmott Magazine, Issue 84, Pages 56–71, July 2016, Available at SSRN: https://ssrn.com/abstract=2883587
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