Quantitative analysis
Let's jump together: pricing credit derivatives
Joao Garcia, Serge Goossens and Wim Schoutens introduce a dynamic multivariate jump-driven model for credit spreads. The model parameters come from a calibration on swaptions and a correlation-matching procedure. The authors apply the model to credit…
Combining the SABR and LMM models
Pierre Henry-Labordere analyses a stochastic volatility Libor market model that combines the SABR and Brace-Gatarek-Musiela (BGM) models in a natural way. Using an innovative geometrical method, he explains how to obtain analytical formulas for swaption…
A free lunch and the credit crunch
Monoline insurers act as triple-A guarantors of the senior risks in structured finance. A purchaser of credit insurance or protection from a monoline may argue that they take only a small amount of the counterparty risk that is a common side-effect of…
Estimating credit contagion in a standard factor model
State-of-the-art credit risk portfolio models and the new Basel capital Accord consider only symmetric dependencies between borrowers in a portfolio, such as correlations. Recently, asymmetric dependencies have been introduced by Davis & Lo (2001), among…
Structural modelling of subprime mortgages
With the economy still suffering from the waves of the credit crunch, triggered by a housing price slump, Yong Kim provides a structural model of subprime mortgages based on housing market risks. Given the enormity of the subprime mortgage market failure…
Valuation and risk analysis for Dutch pension schemes
Technical papers
A multi-state Vasicek model for correlated default rate and loss severity
Correlation between default and recovery has a major bearing on credit risk capital. Rahul Sen shows the effect can be modelled efficiently by allowing multiple loss states in the Vasicek framework. Heavy-tailed distributions result for arbitrary loss…
Explaining the Levy base correlation smile
Joao Garcia and Serge Goossens look at base expected loss at maturity both in the Gaussian copula and Levy-based models, and link it to base correlation in these frameworks. They report on the existence of smile in both base correlation curves and…
Inflation is normal
Chris Kenyon introduces normal-based smile models for year-on-year inflation motivated by the observation that market lognormal caplet volatilities of less than 1% imply normality for maturities of up to 30 years. He is also motivated by the range of…
Estimating intrinsic currency values
Forex market practitioners constantly talk about the strengthening or weakening of individual currencies. In this article, Jian Chen and Paul Doust present a new methodology to quantify these statements in a manner that is consistent with forex market…
On the cost of regulation under Solvency II
Technical papers
Information derivatives
Andrei Soklakov considers the problem of creating derivatives to provide tailored exposure to volatility risk. Information theory leads us to a whole class of such products. This class of 'information derivatives' includes the standard volatility…
Information derivatives
Andrei Soklakov considers the problem of creating derivatives to provide tailored exposure to volatility risk. Information theory leads us to a whole class of such products. This class of 'information derivatives' includes standard volatility products -…
Valuing Tips bond futures with the Jarrow-Yildirim model
Hongming Huang and Yildiray Yildirim apply the Jarrow-Yildirim model to derive a closed-form solution for Treasury inflation-protected securities (Tips) futures. With the issuance of inflation-protected bonds and the impact of inflation on financial…
A multi-state Vasicek model for correlated default rate and loss severity
Correlation between default and recovery has an important bearing on credit risk capital. Here, Rahul Sen shows that the effect can be modelled efficiently by allowing multiple loss states in the Vasicek framework. Heavy-tailed distributions result for…
A short cut to the rainbow
Per Horfelt designs an efficient and accurate method to price many popular multi-asset options such as options on the minimum and maximum of several assets and podiums. The method is based on a modification of the conditional independence model and is…
A bridge between mortgage TBA options and swaptions
Shijun Liu provides basis-point volatility option pricing formulas for swaptions and mortgage to-be-announced options that make direct comparison of volatilities easy and transparent across the two interest rate derivatives markets. Basis-point…
Realisable group diversification effects
Technical papers
Looking forward to back testing
With increasing challenges to measure value-at-risk and meet high regulatory requirements, the focus has turned to back testing as a way of assuring models' adequacy. Carsten S Wehn proposes a new regime of back testing, combining state-of-the-art…
A bridge between mortgage TBA options and swaptions
Interest Rates
Valuing CDOs of ABSs
Charles Smithson and Neil Pearson discuss the valuation of collateralised debt obligations (CDOs), with a close look at CDOs of subprime residential mortage-backed securities
Portfolio modelling of counterparty reinsurance default risk
Technical papers
Information derivatives
This paper considers the problem of creating derivatives to provide tailored exposure to volatility risk
Counterparty risk and CCDSs under correlation
Counterparty risk under correlation is relatively unexplored in the financial literature. Damiano Brigo and Andrea Pallavicini extend previous analysis beyond swap portfolios. A stochastic-intensity jump-diffusion model is adopted for the default event,…