Potential Future Exposure (PFE) is defined as the maximum expected credit exposure over a specified period of time calculated at some level of confidence.
PFE is a measure of counterparty risk/credit risk. It is calculated by evaluating existing trades done against the possible market prices in future during the lifetime of transactions. It can be called sensitivity of risk w.r.t market prices. The calculated expected maximum exposure value is not to be confused with the maximum credit exposure possible. Instead, the maximum credit exposure indicated by the PFE analysis is an upper bound on a confidence interval for future credit exposure.
Credit risk managers have traditionally remained focused on current exposure measurement (i.e., current mark-to-market exposure, plus outstanding receivables) and collateral management. The problem with this focus is that it places excessive emphasis on the present and fails to provide an acceptable indication of credit risk at some point in the future. Because losses from credit risk take a relatively long time to evolve, a more useful measure of exposure is potential exposure. Potential exposure is not like current exposure. It exists in the future and therefore represents a range or distribution of outcomes rather than a single point estimate.
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