Long-Term Portfolio Simulation - For XVA, Limits, Liquidity and Regulatory Capital - Risk Books
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Long-Term Portfolio Simulation - For XVA, Limits, Liquidity and Regulatory Capital

By Alexander Sokol


This book written by leading industry expert, Alexander Sokol, provides a comprehensive reference of market practice and advanced techniques for constructing and calibrating long-term portfolio simulation models.

Long-Term Portfolio Simulation is a must-read for anyone dealing with the unique challenges of simulating large portfolios over long time horizons in the context of CVA, funding, liquidity, collateral optimisation, PFE-based limits and regulatory capital.

Download the Preface and Chapter Four 'Backward Induction' here to get a taster of the book for free.

Publish date: 1 Sep 2014

Availability: In stock

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Long-Term Portfolio Simulation - For XVA, Limits, Liquidity and Regulatory Capital

Book description

The changes in financial markets and regulatory environment following the financial crisis created many new analytics requirements.

These requirements include those for computing CVA. In addition, advanced limit management based on potential future exposure (PFE) has taken an increased role following the crisis. Calculation of PFE-based limits also requires simulation of portfolio to maturity in either risk neutral or real measure. Other important requirements include modelling funding (FVA), collateral needs and cheapest to deliver collateral, and projection of portfolio cashflows for liquidity management.

Previously many of these calculations were only performed by the largest sell side firms. Now, most of them are also required by small and medium banks, as well as asset managers and corporates.

These new requirements can only be met by performing path consistent Monte Carlo simulation of portfolios involving a large number of risk factors over long time horizon (up to and exceeding 30 years).

Written by industry expert Alexander Sokol, this is the first book to focus specifically on model construction and calibration for long-term portfolio simulation. The book offers insider knowledge and techniques for the unique modelling methodologies required in simulating entire portfolios.

The book will address the following topics for multiple asset classes, including interest rate, cross currency and hybrid, CDS and credit products, and structured products:

  • Methodology fundamentals
  • Risk neutral models
  • Real world models
  • Margin period of risk
  • General wrong way risk
  • Systemic wrong way risk
  • Cashflow aggregation
  • American Monte Carlo
  • CVA and funding
  • Collateral optimisation
  • Liquidity and PFE-based limits
  • Regulatory capital

Long-Term Portfolio Simulation is a comprehensive reference for quants responsible for building models for CVA, PFE, limits, liquidity, or funding, as well as those auditing and reviewing the models.

Book details

Book - 9781782720959 / eBook - 9781782721901
Publish date
1 Sep 2014
155mm x 235mm

Author biography

Alexander Sokol

Alexander Sokol is founder and CEO of CompatibL, a software and custom development company specialising in trading and risk management applications, financial analytics, and technical computing. Prior to starting CompatibL in 2003, Alexander was founder and chief technology officer of Numerix, the leading provider of derivatives pricing software, where from 1996 to 2003 he was responsible for the entire R&D effort including quant research and product development.

Alexander’s academic career included faculty positions in theoretical physics at the University of Illinois at Urbana-Champaign and L. D. Landau Institute for Theoretical Physics (Moscow). He holds a PhD in Theoretical Physics from L. D. Landau Institute and an MSc in Physics (with distinction) from the Moscow Institute of Physics and Technology (PhysTech).

Table of contents

Topics covered include:

Methodology fundamentals

  • Risk factor mapping to generic rate and asset factors
  • Model construction in real world measure
  • Model construction in risk neutral measure
  • Principal components analysis
  • Incremental correlation
  • Markovian projection
  • Skew averaging

Risk neutral measure models

  • Techniques for avoiding extreme parameter values
  • Calibration of long dated vol and skew
  • Calibration of correlation

Real world measure models

  • Fundamentals of real world measure simulation
  • Setting long dated drift in real world measure
  • Calibration of stochastic processes
  • Calibration of correlation
  • Trade specific calibration
  • Techniques for avoiding extreme parameter values

Interest rate and inflation

  • OIS and XOIS curves
  • Libor spread curves
  • Inflation
  • Standard risk neutral models
  • Standard real world models


  • Minor currency pairs
  • Hyperinflation
  • Currency collapse
  • Standard risk neutral models
  • Standard real world models


  • Stock index
  • Single stock
  • Stochastic dividends
  • Standard risk neutral models
  • Standard real world models


  • Correlation to equity and FX markets
  • Seasonality
  • Standard risk neutral models
  • Standard real world models


  • Reduced form and structural default models
  • Index and single name CDS
  • Structured credit products
  • Standard risk neutral models
  • Standard real world models


  • Acceleration techniques for linear trades
  • Acceleration techniques for nonlinear trades
  • Path consistent valuation using trade specific models
  • Path consistent out of model valuation


  • Margin period of risk
  • Cash collateral in bilateral trading
  • Non-cash collateral in bilateral trading
  • CCP collateral

Wrong way risk

  • General wrong way risk
  • Modelling portfolios of CDS
  • Systemic wrong way risk
  • Calibration methods


  • CVA
  • Funding
  • Cheapest to deliver collateral
  • PFE limits
  • Regulatory limits
  • Cost of regulatory capital
  • Cost of economic capital
  • Expected cashflows
  • Liquidity measures

Customer Reviews

Average customer reviews for Long-Term Portfolio Simulation - For XVA, Limits, Liquidity and Regulatory Capital

Excellent book written by a practitioner

Calculation of risk measures like XVA, PFE, EAD or risk capital requires simulation of portfolio over long term horizon, like months or years. Such simulation is different in many aspects and definitely more challenging than a simulation for purposes of pricing or VaR. Long term simulation must be built on three areas: the first being the theoretical foundations of XVA adjustments, the second involving Monte Carlo techniques and the third market risk and risk neutral valuation. Considered separately, each of these areas is extensively covered in the literature. The author set himself a very ambitious task of writing a book intended to connect these areas and provide insight into the theory and techniques of long term portfolio simulation that combines these three building blocks and he definitely succeeded in his task.

The first impression when reading the book is the vastness of material covered and the amount of details and insights provided. Some chapters could easily be expanded into separate books. This also sets the expectation regarding the reader - although the author is very intuitive in his considerations, the reader should be familiar with risk neutral valuation of derivatives, Monte Carlo simulation, and have general market and credit risk background to fully appreciate the book.

The pivotal idea of the book is that long term portfolio simulation uses real world measures alongside risk neutral measures. When to use each of these two measures and how to transition from one of them into the other is the common thread throughout the whole book. The author provides the overview of the literature and the state of the research regarding these methods and techniques, adding his comments from the practitioner point of view.

Let me give a quick overview of the chapters. The first one, called "Applications" discusses the modelling of exposure and XVA adjustments, the role of margin period of risk and usage of real world and risk neutral measures.

The second chapter is devoted to modelling correlation and cointegration. The author discusses the advantages and disadvantages of various methods and techniques like PCA, incremental correlation, correlation skew, dependence mapping, empirical copula, cointegration.

The next chapter is devoted to the model setup. The author discusses how to organize a model for a big portfolio so that the model complexity is tractable and the simulation gives right results. The author discusses simulation under real world and risk neutral measures, path consistency, techniques used for changing of measure; primary, incremental and external models.

The fourth chapter is devoted to American Monte Carlo technique.

Subsequent chapters focus on three important asset classes: interest rates, FX and credit spreads. A lot of attention is given to the techniques of changing the measure between risk neutral and real world for these particular asset classes.

The last chapter is an overview of methods for modelling wrong way risk.
Review by M Siomak , 23/07/2015

real-world drift vs risk-neutral drift

Great book and reference for such an important topic for everyone involved in long-horizon simulation and its application in CVA estimation and models for limits, liquidity, and regulatory capital. Although this book is focused on IR and FX simulation I found interesting ideas for commodities.
Review by Esoriano , 08/01/2015

great accomplishment

Long-Term Portfolio Simulation is a great accomplishment: a very readable, accurate, and complete reference work for an hot topic that will become more and more relevant in the coming years
Review by Ferdinando Ametrano , 14/12/2014

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