Choosing Interest Rate Models for Vanilla Swap PFE

Summary

The document raises a model-selection question for estimating potential future exposure (PFE) on a vanilla interest rate swap. It considers Monte Carlo scenarios from a one-factor Hull–White model and questions whether its parallel curve shifts can represent realistic future mark-to-market values.

No answer, comparison, or empirical evidence is provided, so the document does not establish which model or market practice is appropriate. Its useful contribution is to identify a limitation to examine: a one-factor rate model may not capture changes in curve shape. Any conclusion about PFE quality would require further analysis of the exposure purpose, model calibration, risk factors, and validation against relevant market behavior.

Key ideas

• The document asks whether a one-factor Hull–White model is appropriate for swap PFE simulation.
• It questions whether parallel curve deformations produce representative future swap valuations.
• It provides no answer or evidence on prevailing market practice.

Tags

# Potential Future Exposure for vanilla swap


# Potential Future Exposure for vanilla swap












I need to calculate the PFE for vanilla swap. I wonder if it makes sense to simulate the MC scenarios with a 1-factor Hull white model. In my opinion, this model only allows parallel curve deformations and future MTMs would not be representative of reality! I would like to know what market practice is?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.