Topic 22 – Netting and Aggregation

1. What “netting” means in risk terms

For pricing / market risk:

• Portfolio PV is just the sum of trade PVs: $$\text{PV}_{\text{portfolio}} = \sum_{j=1}^N \text{PV}_j$$
• Same for sensitivities: $$s_i^{\text{portfolio}} = \sum_j s_{i,j}$$ where $s_{i,j}$ is sensitivity of trade $j$ to factor $i$.

Important distinction:

• Gross exposure:
  • Sum of absolute notionals or sensitivities.
• Net exposure:
  • Sum with signs (long vs short).

Example:

• Long 100 MW, short 90 MW of same product:
  • Gross = 190 MW.
  • Net = 10 MW.

Netting is why a huge book can have modest net risk.

2. Aggregation across trades, books, desks

You usually have a hierarchy:

• Trade → Book → Desk → Business line → Entity → Group

For each level, you aggregate:

• PV,
• Sensitivities by risk factor (curve buckets, vols, spreads, basis),
• Scenario P&L, VaR contributions.

Key technical piece: consistent risk-factor mapping.

• Each trade maps to the same factor set.
• A “Cal-27 base” factor means the same thing across desks.
• Without that, netting and aggregation are meaningless.

3. Netting examples that matter on a power/commodities book

• Time bucket netting:
  • Long Winter-27, short Cal-27 → residual exposure in Summer-27.
• Location netting:
  • Long physical at zone, short at hub → residual basis risk.
• Product-shape netting:
  • Long baseload, short peakload → residual shape risk (peak vs off-peak).

You care about:

• Where net level risk sits (overall price),
• Where net shape risk sits (seasonality, base/peak),
• Where net basis risk sits (locations, hubs).

Risk reports should show this clearly.

4. Analytical netting vs legal netting

Two different concepts:

1. Analytical netting (what we are doing here):
   • PV and sensitivities cancel when they refer to the same risk factor.
   • Drives market risk, VaR, scenarios, hedging.
2. Legal / CSA netting:
   • Contracts netted by:
     • Counterparty,
     • Netting agreement,
     • Collateral agreement (CSA).
   • Drives counterparty exposure, CVA/XVA, margin.

For interviews as quant dev:

“I understand analytical netting (PV and risk factors) and I’m aware legal netting-sets exist for exposure/XVA.”

5. How to say it simply

“At analytics level, PVs and sensitivities add linearly, so we net exposures to risk factors across trades into books and desks. This shows where the true level, shape, and basis risks sit after offsetting long and short positions. On top of that, legal netting-sets and CSAs determine how exposures net for counterparty and XVA purposes.”