The credit crisis of 2008 stressed the financial system
considerably. The bankruptcy of some of the significant players
such as Lehman, have led market participants to re-evaluate the
pre-crisis view that counterparties are largely risk free. This has
brought about an increased focus on counterparty risk management
practices as participants try to bolster their systems and
infrastructure to correctly assess and monitor these risks.
This calls for building sophisticated Monte Carlo simulation
engines for calculating key exposure measures, such as Potential
Future Exposure (PFE) and Expected Positive Exposure (EPE). PFE is
the maximum amount of Expected Exposure (EE) on a future date with
a certain degree of statistical confidence. EPE is the average
exposure on a future date. Further, these exposures could be
positively or negatively correlated with the credit risk of the
counterparty resulting in wrong way or right way risk.
