New framework for algo exposures and CVA unveiled by Numerix for derivatives

19 July 2012

Numerix has released a new theoretical algorithmic method for calculating counterparty exposures for exotic derivatives and a way to automate its risk assessment calculations.

The analytic firm has outlined the new approaches in its quantitative research entitled ‘Algorithmic Exposure and Credit Value Adjustment (CVA) for Exotic Derivatives’, which was written by Alexander Antonov, Serguei Issakov and Serguei Mechkov.

The paper establishes a new algorithmic method for calculating counterparty exposures and automates its application for computing Monte Carlo simulated measures for assessing market risk and counterparty risk, including Monte Carlo Value at Risk (VaR), expected shortfall, potential future exposure (PFE) and CVA.

“This paper introduces a theoretical framework that can be used to reconcile various approaches to computing risk with the same level of speed and accuracy as pricing, helping to create a common language for the front and middle offices,” said Issakov, senior vice president of quantitative research and development at Numerix. “While there is a consensus on how to compute price, there are various approaches to achieve risk computations, which don’t always agree with each other. We found that by calculating exposure in parallel with pricing a unified, more efficient approach can be taken to computing complex risk measures.”

Fundamental to this approach is the concept of exposure-centric analytics, which generalises the existing price-centric analytics, as a rigorous framework for computing market risk and counterparty risk. As such, this method also naturally lends itself to computing economic scenario generators (ESGs) by applying economic variables to the scenario generation framework.

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