PFE vs EPE — what's the difference and when do I use each?

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AcadiFi · Accepted Answer

PFE and EPE measure different things for different purposes. PFE (potential future exposure) is a high-percentile (e.g., 97.5%) tail measure of exposure at a specific future point in time — it answers 'how bad could exposure get in a stress scenario?' EPE (expected positive exposure) is the time-average of expected exposure over a horizon (typically one year) — it answers 'what's the average exposure we carry over this period?' PFE is used for credit limit setting because limits need to control worst-case exposure. EPE is used for regulatory capital (EAD = 1.4 x effective EPE under IMM) because capital is calibrated to loss expectations, not tail events. Here's a side-by-side for a netting set with Vanguard Helix Partners. ```mermaid flowchart LR A[Exposure Metrics] --> B[PFE
97.5 percentile] A --> C[EPE
1y time-average] B --> D[Credit Limits] C --> E[Regulatory EAD] ``` Numerically: for a 10y IRS portfolio EE profile peaking at $15M, 97.5% PFE might be $42M at peak, while one-year EPE might be $8M. The capital charge using 1.4 x EPE = $11.2M EAD differs dramatically from the $42M PFE limit. Both are legitimate for their respective purposes. A sophisticated bank reports and monitors both, plus stressed versions under adverse macro scenarios. Our FRM Part II CCR module breaks down each metric with computation examples and regulatory references.

PFE vs EPE — what's the difference and when do I use each?

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