How do I interpret and compute an expected exposure profile?

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AcadiFi · Accepted Answer

Expected exposure at time t is E[max(0, MTM(t))] under the physical (or sometimes risk-neutral) measure, averaged across thousands of Monte Carlo scenarios. Computation: simulate N paths of underlying risk factors from t=0 to trade maturity, revalue the netting set at each time grid point, take max(0, value) to reflect the one-way nature of exposure, and average across paths at each time. For a 5-year IRS with Kestrelbay Asset Management where we pay fixed 3.8% receive SOFR on $200M notional, if SOFR rates move down 50bp broadly, our MTM becomes positive; if rates move up, MTM goes negative and exposure is zero (from our side). The EE profile captures the mean positive excursion. Interpretation tips. First, EE peaks typically occur at the midpoint to two-thirds of the trade's life for vanilla swaps, balancing cumulative diffusion against amortizing remaining cash flows. Second, EE for FX trades often grows monotonically because FX has no amortization effect. Third, optionality (caps, swaptions) creates fat-tailed exposure profiles — EE can be much smaller than PFE. Fourth, netting across many trades with a single counterparty typically reduces total EE by 40-60% versus sum of gross exposures. Use EE profiles for CVA pricing (discounted EE integrated against marginal PD times LGD) and EPE for regulatory capital inputs.

How do I interpret and compute an expected exposure profile?

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