Technical paper
Backwardation and contango change indicators for seasonal commodities
In the first part of this two-part article, Svetlana Borovkova introduced two indicators for detecting changes between backwardation and contango market states. Here, in the second part, she applies the indicators to seasonal commodities and introduces a…
Questions of error
Consider the following two, difficult, questions. How should a financial institution allocate capital to different businesses? How should a financial institution be valued? The first question is a subject for the senior management of an institution. But…
Market-implied ratings
There has been much debate over the respective merits of credit ratings and market-based indicators. Ludovic Breger, Lisa Goldberg and Oren Cheyette present a new approach that tries to incorporate the benefits of both approaches. Starting with agency…
Overcoming the hurdle
How should capital be allocated to different business lines in a financial institution? Thomas Wilson explores this question from an investor’s perspective by constructing a statistical model that measures the risk of individual business types. The…
Correlation evidence
Like ratings, default correlation is an area of fierce industry debate. But any fundamental, long-term investor searching for fair value in credit correlation will want to understand what the historical data actually says. Here, Arnaud de Servigny and…
Operational risk: a practitioner's view
The Basel Committee on Banking Supervision ("the Committee") released aconsultative document that included a regulatory capital charge for operationalrisk. Since the release of the document, the complexity of the concept of "operationalrisk" has led to…
I will survive
Jon Gregory and Jean-Paul Laurent apply an analytical conditional dependence framework to the valuation of default baskets and synthetic CDO tranches, matching Monte Carlo results for pricing and showing significant improvement in the calculation of…
Bidding principles
Robert Almgren and Neil Chriss show how principal bid programme trades can be priced and evaluated as part of a trading business. By annualising the price impacts and variances of such trades, they construct an information ratio measure that can be used…
Credit barrier models
Claudio Albanese, Giuseppe Campolieti, Oliver Chen and Andrei Zavidonov construct an analytic credit barrier model driven by credit ratings, constrained to fit the term structure of credit spreads
Detecting market transitions: from backwardation to contango and back
Svetlana Borovkova looks at detecting market transitions between backwardation and contango states using the forward curve. In this first part of a two-part article, she introduces two change indicators, which she applies to oil futures prices. Next…
Black smirks
Fei Zhou presents a simple stochastic volatility extension of the Black interest rate option pricing model widely used by traders. Using a perturbative expansion in volatility of volatility, he derives modified Black formulas that correctly fit the…
Real option valuation and equity markets
Many non-financial assets can be viewed as ‘real options’ linked to some underlying variable such as a commodity price. Here, Thomas Dawson and Jennifer Considine show that the stock price of a well-known electricity generating company is significantly…
Pitfalls and alternatives
Correlation
The road to partition
Applying the ensemble approach developed in these pages last month, Kevin Thompson and Roland Ordovas calculate risk contributions and show how to measure higher-order default dependence using the method of partitions. The results provide tools allowing…
Applying modern portfolio theory to optimal gas purchasing
Yijun Du and Xiaorui Hu present a general framework for applying modern portfolio theory to optimal natural gas procurements. They show that successful natural gas procurement involves determining the optimal allocation between fixed-price and floating…
A better approach to operational risk aggregation
Professor Carol Alexander proposes an aggregation methodology that takes account of dependencies between op risk losses that have some common risk drivers.