A Practical Guide to Monte Carlo CVA

Alexander Sokol


Introduction to 'Lessons from the Financial Crisis'


The Credit Crunch of 2007: What Went Wrong? Why? What Lessons Can be Learned?


Underwriting versus Economy: A New Approach to Decomposing Mortgage Losses


The Shadow Banking System and Hyman Minsky’s Economic Journey


The Collapse of the Icelandic Banking System


The Quant Crunch Experience and the Future of Quantitative Investing


No Margin for Error: The Impact of the Credit Crisis on Derivatives Markets


The Re-Emergence of Distressed Exchanges in Corporate Restructurings


Modelling Systemic and Sovereign Risks


Measuring and Managing Risk in Innovative Financial Instruments


Forecasting Extreme Risk of Equity Portfolios with Fundamental Factors


Limits of Implied Credit Correlation Metrics Before and During the Crisis


Another view on the pricing of MBSs, CMOs and CDOs of ABS


Pricing of Credit Derivatives with and without Counterparty and Collateral Adjustments


A Practical Guide to Monte Carlo CVA


The Endogenous Dynamics of Markets: Price Impact, Feedback Loops and Instabilities


Market Panics: Correlation Dynamics, Dispersion and Tails


Financial Complexity and Systemic Stability in Trading Markets


The Martingale Theory of Bubbles: Implications for the Valuation of Derivatives and Detecting Bubbles


Managing through a Crisis: Practical Insights and Lessons Learned for Quantitatively Managed Equity Portfolios


Active Risk Management: A Credit Investor’s Perspective


Investment Strategy Returns: Volatility, Asymmetry, Fat Tails and the Nature of Alpha

The regulatory and internal requirement to measure counterparty risk pre-dates the financial crisis by many years. Most firms carrying derivatives books had the ability to compute counterparty exposures for their trades, and many had built sophisticated Monte Carlo systems to do so. The only thing that was missing was taking the possibility of default seriously. Because of the perceived low probability of default, enormous exposures were allowed to build up at some firms without raising any alarms. For the same reason, the information on exposures available to market participants prior to the crisis was often not used to mitigate counterparty risk despite the low cost of credit insurance in pre-crisis years.

The financial crisis brought new urgency to the efforts in implementing calculation of potential future exposure (PFE) and credit value adjustment (CVA). Having seen the default of Lehman Brothers, and near default of other firms, the market participants were for the first time taking seriously the risk of default and assigning a more realistic probability to it, as evidenced by the dramatic widening of credit spreads during and immediately after the crisis. The increased

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