Counterparty Trading Limits Revisited:CSAs, IM, SwapAgent(r), from PFE to PFL

Chris Kenyon, Mourad Berrahoui and Benjamin Poncet

Papers from arXiv.org

Abstract: The utility of Potential Future Exposure (PFE) for counterparty trading limits is being challenged by new market developments, notably widespread regulatory Initial Margin (using 99% 10-day exposure), and netting of trade and collateral flows. However PFE has pre-existing challenges w.r.t. portfolios/distributions, collateralization, netting set seniority, and overlaps with CVA. We introduce Potential Future Loss (PFL) which combines expected shortfall (ES) and loss given default (LGD) as a replacement for PFE. With two additional variants Adjusted PFL (aPFL) and Protected Adjusted PFL (paPFL) these deal with both new and pre-existing challenges. We provide a theoretical background and numerical examples.

Date: 2017-10, Revised 2018-11
New Economics Papers: this item is included in nep-cta, nep-rmg and nep-upt
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