Modern Credit Value Adjustment

Abstract: Counterparty risk calculations have gained importance after the latest financial crisis. The bankruptcy of Lehman Brothers showed that even large financial institutiones face a risk of default. Hence, it is important to measure the risk of default for all the contracts written between financial institutions. Credit Value Adjustment, CVA, is an industry standard method for such calculations. Nevertheless, the implementation of this method is contract dependent and the necessary computer simulations can be very intensive. Monte Carlo simulations have for a long time been known as a precise but slow technique to evaluate the cash flows for contracts of all kinds. Measuring the exposure of a contract written on structured products might require half a day of calculations if the implementation is written without significant optimization. Several ideas have been presented by researchers and applied in the industry, the idea explored and implemented in this thesis was based on using Artificial Neural Networks in Python. This procedure require a decomposition of the Expected Exposure calculation within the CVA and generating a large data set using a standard Monte Carlo simulation. Three network architectures have been tested and the final performance was compared with using standard techniques for the very same calculation. The performance gain was significant, a portfolio of 100 counterparties with 10 contracts each would take 20 minutes of calculations in total when using the best performing architecture whereas a parallel C++ implementation of the standard method would require 2.6 days.