In this section, we define the measures commonly used to quantify exposure. The different metrics introduced will be appropriate for different applications. There is no standard nomenclature used and some terms may be used in other contexts elsewhere. We follow the Basel Committee on Banking Supervision (2005) definitions, which are probably the most commonly used although, unfortunately, not the most intuitively named.
We begin by defining exposure metrics for a given time horizon. Note that in discussing exposure below, we are referring to the total number of relevant trades, netted appropriately and including any relevant collateral amounts. We will refer to this as the netting set.
This component represents the forward or expected value of the netting set at some point in the future. As mentioned above, due to the relatively long time horizons involved in measuring counterparty risk, the expected value can be an important component, whereas for market risk VAR assessment (involving only a time horizon of 10 days), it is not. Expected future value (EFV) may vary significantly from current value for a number of reasons: