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Fast Calculation of Credit Exposures for Barrier and Bermudan options using Chebyshev interpolation

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  • Kathrin Glau
  • Ricardo Pachon
  • Christian Potz

Abstract

We introduce a new method to calculate the credit exposure of Bermudan, discretely monitored barrier and European options. Core of the approach is the application of the dynamic Chebyshev method of Glau et al. (2019). The dynamic Chebyshev method delivers a closed form approximation of the option prices along the paths together with the options' delta and gamma. Key advantage is the polynomial structure of the approximation, which allows us a highly efficient evaluation of the credit exposures, even for a large number of simulated paths. The approach is highly flexible in the model choice, payoff profiles and asset classes. We compute the exposure profiles for Bermudan and barrier options in three different equity models and compare them to the profiles of European options. The analysis reveals potential shortcomings of common simplifications in the exposure calculation. The proposed method is sufficiently simple and efficient to avoid such risk-bearing simplifications.

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  • Kathrin Glau & Ricardo Pachon & Christian Potz, 2019. "Fast Calculation of Credit Exposures for Barrier and Bermudan options using Chebyshev interpolation," Papers 1905.00238, arXiv.org.
    • Handle: RePEc:arx:papers:1905.00238
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    1. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," The Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 113-147.
    2. Schroder, Mark Douglas, 1989. " Computing the Constant Elasticity of Variance Option Pricing Formula," Journal of Finance, American Finance Association, vol. 44(1), pages 211-219, March.
    3. Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
    4. Maximilian Gaß & Kathrin Glau & Mirco Mahlstedt & Maximilian Mair, 2018. "Chebyshev interpolation for parametric option pricing," Finance and Stochastics, Springer, vol. 22(3), pages 701-731, July.
    5. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," University of California at Los Angeles, Anderson Graduate School of Management qt43n1k4jb, Anderson Graduate School of Management, UCLA.
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    Cited by:

    1. Mariano Zeron & Ignacio Ruiz, 2020. "Dynamic sensitivities and Initial Margin via Chebyshev Tensors," Papers 2011.04544, arXiv.org.

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