October 31, 2005
Fooled by Randomness 2005
One of the best conference programs for quantitative risk
analysis: Fooled by Randomness 2005. text, PDF.
Posted by omor at 01:32 AM | Comments (0)
October 19, 2005
Credit Risk Models II: Structural Models. (Elizalde)
Credit Risk Models II: Structural Models
July 2005
The structural approach for modelling credit risk considers both
the case of a single firm and the case with default dependences
between firms.
In the single firm case, we review the Merton (1974) model and
first passage models, based on Black & Cox (1976), examining
their main characteristics and extensions. The issue of estimating
structural models is also addressed, covering the different ways
proposed in the literature.
The issue of estimating structural models is also addressed,
covering the different ways proposed in the literature.
Secondly, we model default dependences among firms, which account
for two types of default correlations: cyclical default correlation
and contagion effects. We close with a brief mention of factor models.
The paper guides readers throught the literature, providing a
comprehensive list of references and, along the way, suggesting
different possible extensions for its future development.
[PDF]
Abel Elizalde of CEMFI and Universidad Pública de Navarra
Posted by omor at 02:04 AM | Comments (0)
September 10, 2005
Volatility vs Liquidity
Traditionally, economists have thought that big up-and-down
fluctuations in returns indicated risky investments, so many hedge
fund investors have hoped to see a pattern of smooth and even returns.
Andrew Lo quickly saw that lots of hedge funds were posting returns
that were just too smooth to be realistic. Digging deeper, he found
that funds with hard-to-appraise, illiquid investments - like real
estate or esoteric interest rate swaps - showed returns that were
particularly even. In those cases, he concluded, managers had no way
to measure their fluctuations, and simply assumed that their value was
going up steadily. The problem, unfortunately, is that those are
exactly the kinds of investments that can be subject to big losses in
a crisis. In 1998, investors retreated en masse from such investments.
Mr. Lo came to a disturbing conclusion: that smooth returns,
far from proving that hedge funds are safe, may be a warning
sign for the industry.
[NYT]
Posted by omor at 10:54 AM | Comments (0)
August 27, 2005
Non-Gaussian Panel Time Series Model Decomposing Default Risk
We model 1980--2003 rating and cohort specific cumulative default
frequencies. The data is decomposed into systematic and firm-specific
risk components. We have to cope with
(i) the shared exposure of each cohort and rating class to the same
systematic risk factor;
(ii) strongly non-Gaussian features of the individual time series;
(iii) possible dynamics of the unobserved common risk factor;
(iv) changing default probabilities per rating cohort over time
(ageing effects), and
(v) missing observations. We propose a non-Gaussian multivariate state
space model that simultaneously deals with all of this issues.
The model is estimated using importance sampling techniques.
A NON-GAUSSIAN PANEL TIME SERIES MODEL FOR ESTIMATING AND
DECOMPOSING DEFAULT RISK
Session Credit Risk
Field Finance
Session Chair Haibin Zhu, Bank for International Settlements
Presenter(s) Robert J.O. Daniels, De Nederlandsche Bank
Co-Author(s) Andre Lucas, Vrije Universiteit Amsterdam and
Tinbergen Institute and Siem Jan Koopman, Vrije Universiteit Amsterdam
Topics Banking, Empirical Finance, Financial Econometrics and State
Space and Factor Models
Keywords credit risk, importance sampling, multivariate
unobserved components models and non-Gaussian state space models
JEL Codes C32, G21
Posted by omor at 06:13 PM | Comments (0)
August 26, 2005
Macroeconomic determinants of the yield curve
Macroeconomic variables besides inflation and real activity drive the
yield curve in the framework of no-arbitrage affine term structure
models. We construct model-based projection of all the latent factors
onto the observable macro factors, which are real activity and
inflation.
As a result, the factors are decomposed into the “macro” part: a
linear function of the macro variables and their lags; and the truly
novel part which is orthogonal to the entire history of the macro
variables. We are able to relate the unexplained part of the short
rate to such measures of liquidity as the AAA credit spread and MZM
growth rate. The unexplained part of the slope is highly correlated
with the budget deficit.
NO-ARBITRAGE MACROECONOMIC DETERMINANTS OF THE YIELD CURVE
Session Term Structure Models
Field Finance
Session Chair Ricardo Brito, Ibmec São Paulo
Presenter(s) Ruslan Bikbov, Columbia Business School
Co-Author(s) Mikhail Chernov, Columbia Business School
Topics Asset Pricing, Empirical Finance, Financial Econometrics and
State Space and Factor Models
Keywords Affine models, Credit Spread, dynamic no-arbitrage
models, Liquidity, Monetary policy, MZM money, Public debt, Taylor
Rules, Term Structure of Interest rates and Vector Auto Regression
JEL Codes E43, E44, G12
Posted by omor at 06:12 PM | Comments (0)
August 21, 2005
Efficient Calibration for Libor Market Models
LMM Calibrator Estimation of volatility and correlation parameters in
the sense of (Brigo and Mercurio 2001), (Brigo and Morini 2004) and
(Brigo, Mercurio, and Morini 2005)
- Estimate volatilities from Caps/Floors
- Rescale volatilities to the needed Libor maturity
- Extract correlation parameters from swaption volatilities
Alternative strategies and implementation issues, Thomas Weber, .
See also Interest rate modelling, Brigo, Mercurio, Pelsser.
Posted by omor at 11:02 PM | Comments (0)
July 27, 2005
Correlation-dependent Credit Structural Model
In 1976 Black and Cox proposed a structural model where an obligor
defaults when the value of its assets hits a certain barrier. In 2001
Zhou showed how the model can be extended to two obligors whose assets
are correlated. In this paper we show how the model can be extended to
a large number of different obligors. The correlations between the
assets of the obligors are determined by one or more factors.
We examine the dynamics for credit spreads implied by the model and
explore how the model price tranches of collateralized debt
obligations (CDOs). We compare the model with the widely used Gaussian
copula model of survival time and test how well the model fits market
data on the prices of CDO tranches.
We consider two extensions of the model. The first reflects empirical
research showing that default correlations are positively dependent on
default rates. The second reflects empirical research showing that
recovery rates are negatively dependent on default rates.
The Valuation of Correlation-dependent Credit Derivatives Using a
Structural Model
John Hull, Mirela Predescu, and Alan White
Posted by omor at 06:51 PM | Comments (0)
July 25, 2005
Optimal Recursive Refinancing and the Valuation of Mortgage-Backed Securities (Longstaff)
The optimal recursive refinancing problem where a borrower minimizes
his lifetime mortgage costs by repeatedly refinancing when rates
drop. Key factors affecting the optimal decision are the cost of
refinancing and the possibility that the mortgagor may have to
refinance at a premium rate because of his credit.
The optimal recursive strategy often results in prepayment being
delayed significantly relative to traditional models. Furthermore,
mortgage values can exceed par by much more than the cost of
refinancing. Applying the recursive model to an extensive sample of
mortgage-backed security prices, we find that the implied credit
spreads that match these prices closely parallel borrowers’ actual
spreads at the origination of the mortgage. These results suggest
that optimal recursive models may provide a promising alternative
to the reduced-form prepayment models widely used in practice.
Francis A. Longstaff, Anderson School of Management.
Francis A. Longstaff, "Optimal Recursive Refinancing and the Valuation
of Mortgage-Backed Securities" (December 1, 2002). Finance. Paper 15-02.
Posted by omor at 07:49 PM | Comments (0)
July 23, 2005
Modelling Dependence with Copulas for Risk Management
Modelling of dependence is one of the most rucial issues in risk
management. Whereas classically independence was equated to linear
correlation, more recently, mainly due to extremal market moves,
the limitations of the linear correlation concept were strongly felt.
In order to stress test dependence in a financial or insurance
portfolio, the notion of copula offers a versatile tool.
* Basic properties of copulas,
* The underlying simulation and numerical issues,
* Use of copula based techniques in integrated risk management.
[*]
Posted by omor at 06:25 PM | Comments (0)
July 22, 2005
Dependence Modelling in Risk Management
* Simulation of dependent risks,
* Statistical estimation of correlation in the static case,
* Dependence and correlation in a dynamically changing environment
* Extremes for heavy-tailed random vectors and multivariate stochastic processes.
Crucial to questions of risk aggregation, the project aims to
establish the fundamentals of dependence and correlation modelling.
Posted by omor at 06:30 PM | Comments (0)
July 21, 2005
Asset prices by Enricode Giorgi
Default models and asset pricing models at Enricode Giorgi's resource,
some with correlated defaults.
Posted by omor at 02:12 PM | Comments (0)
July 15, 2005
OAS measure of yield
OAS measure of yield has been introduced to accurately price callable
bonds but is also used now as a measure for bullets' yield.
1. For bullets, it is more accurate than yield to maturity (YTM) as
a. You use implied forward rates instead of the yield to maturity as
a reinvestment rate.
b. You discount using the zero cpn curve instead of the YTM
Even more, you calibrate your forward rates so that the PV of yor
coupons match the market values.
2. For callable bonds and MBS, the YTM measure also assumes holding
till maturity which is obviously inaccurate so the OAS uses binomial
tree which takes into account the contingency of the future coupons.
The OAS is a constant spread to the whole discount curve you use
( e.g. treasury) which would result in a PV equal to the market price.
[Wilmott (Sun Apr 27, 03 06:01 PM )]
Posted by omor at 06:04 PM | Comments (0)
June 07, 2005
Kay Giesecke Credit Modeller at Cornell OR
Kay Giesecke (of Cornell's School of Operations Research and Industrial Engineering)
research interests (Credit Risk, Default Correlation, Credit Derivatives, Systemic Risk)
match his research.
Posted by omor at 06:39 PM | Comments (0)
June 03, 2005
Handbook of Fixed Income Securities (Fabozzi)
The Handbook of Fixed Income Securities
Edited by Frank Fabozzi
Hardcover: 1500 pages
Publisher: McGraw-Hill; 7 edition (April 1, 2005)
ISBN: 0071440992
Part 1. Background.
Background.
1. Overview of the Types and Features of Fixed Income Securities.
2. Risks Associated with Investing in Fixed Income Securities.
3. A Review of the Time Value of Money.
4. Bond Pricing and Return Measures.
5. Measuring Interest Rate Risk.
6. The Sturcture of Interest Rates.
7. Bond Market Indexes.
Part 2. Government and Private Debt Obligations.
8. U.S. Treasury and Agency Securities.
9. Municipal Bonds.
10. Private Money Market Instruments.
11. Corporate Bonds.
12. Medium-Term Notes.
13. Inflation-Indexed Bonds (Tips).
14. Floating-Rate Securities.
15. Nonconvertible Preferred Stock.
16. International Bond Markets and Instruments.
17. Brady Bonds.
18. Stable Value Investments.
Part 3. Credit Analysis.
19. Credit Analysis for Corporate Bonds.
20. Credit Considerations in Evaluating High-yield Bonds.
21. Investing in 11 and Other Distressed Companies.
22. Guidelines in the Credit Analysis of General Obligation and Revenue Municipal Bonds.
23. High-Yield Analysis of Emerging Markets Debt.
Part 4. Mortgage-Backed and Asset-Backed Securities.
24. Mortgages and Overview of Mortgage-Backed Securities.
25. Mortgage Pass-Throughs.
26. Collateralized Mortgage Obligations.
27. Nonagency CMOs.
28. Commercial Mortgage-Backed Securities.
29. Securities Backed by Automobile Loans.
30. Securities Backed by Closed-End Home Equity Loans.
31. Securities Backed by Manufactured Housing Loans.
32. Securities Backed by Credit Card Receivables.
Part 5. Fixed Income Analytics and Modeling.
33. Characteristics of and Strategies with Callable Securities.
34. Valuation of Bonds with Embedded Options.
35. Valuation of CMOs.
36. Fixed Income Risk Modeling.
37. OAS and Effective Duration.
38. Evaluation Amortizing ABS. A Primer on Static Spread.
Part 6. Portfolio Management.
39. Bond Management. Past, Current, and Future.
40. The Active Decisions in the Selection of Passive Management and Performance Bogeys.
41. Managing Indexed and Enhanced Indexed Bond Portfolios.
42. Global Corporate Bond Portfolio Management.
43. Management of a High-Yield Bond Portfolio.
44. Bond Immunization. An Asset/Liability Optimization Strategy.
45. Dedicated Bond Portfolios.
46. Managing Market Risk Proactively at Long-Term Investment Funds.
47. Improving Insurance company Portfolio Returns.
48. International Bond Investing and Portfolio Management.
49. International Fixed Income Investing. Theory and Practice.
Part 7. Equity-Linked Securities and Their Valuation.
50. Convertible Securities and Their Investment Characterics.
51. Convertible Securities and Their Valuation.
Part 8. Derivative Instruments and Their Portfolio Management Applications.
52. Introduction to Interest-Rate Futures and Options Contracts.
53. Pricing Futures and Portfolio Applications.
54. Treasury Bond Futures Mechanics and Basis Valuation.
55. The Basics of Interest-Rate Options.
56. Controlling Interest Rate Risk and Futures and Options.
57. Interest-Rate Swaps.
58. Interest-Rate Caps and Floors and Compound Options.
Posted by omor at 12:00 PM | Comments (0)
June 02, 2005
Fixed Income Securities: Tools for Today's Markets (Tuckman)
Fixed Income Securities: Tools for Today's Markets,
Second Edition by Bruce Tuckman.
1. THE RELATIVE PRICING OF FIXED INCOME SECURITIES WITH FIXED CASH FLOWS.
# Bond Prices, Discount Factors, and Arbitrage.
# Bond Prices, Spot Rates, and Forward Rates.
# Yield to Maturity.
# Generalizations and Curve Fitting.
2. MEASURES OF SENSITIVITY AND HEDGING.
# One-Factor Measures of Sensitivity.
# Measures of Price Sensitivity Based on Parallel Yield Shifts.
# Key Rate and Bucket Exposures.
# Regression-Based Hedging.
3. TERM STRUCTURE THEORY AND MODELS.
# The Science of Term Structure Models.
# The Short-Rate Process and the Shape of the Term Structure.
# The Art of Term Structure Models: Drift.
# The Art of Term Structure Models: Volatility and Distribution.
# Multi-Factor Term Structure Models.
# Trading with Term Structure Models.
4. ANALYSIS OF SELECTED SECURITIES.
# Repo.
# Forward Markets.
# Eurodollar and Fed Fund Futures.
# Interest Rate Swaps.
# Fixed Income Options.
# Note and Bond Futures.
# Mortgage-Backed Securities.
Posted by omor at 11:50 AM | Comments (0)
May 31, 2005
Derivatives Portal
Derivatives Portal risk and finance papers, journals, books, conferences.
More background than trade press touts.
Recommended.
Posted by omor at 09:49 PM | Comments (0)
May 18, 2005
financialbulls
financialbulls by JW O'Brien looks at financial engineering
and risk management in real life.
Posted by omor at 05:33 PM | Comments (0)
April 26, 2005
Residential Mortgage Termination and Severity, De Franco
Modeling Residential Mortgage Termination and Severity
Using Loan Level Data
Three essays on modeling residential mortgages.
Chapter 1 presents and estimates a new model of loss given
default using a new dataset of prime and subprime mortgages. The
model combines option theory proxies with information on the loan
contract and the cash flow position of the borrower. The results
suggest that severity on subprime and adjustable rate mortgages are
similar to losses on fixed rate prime loans, but that investor owned
properties have significantly higher losses than owner occupied
houses. The results also suggest systemic overappraisals on refinanced
loans.
Chapter 2 uses option pricing methodology to value the prepayment and
default options associated with a residential mortgage, if house
prices are mean reverting.
Numerical solutions compare the results from the mean reverting house
price model to the results from a model where house prices follow a
geometric Brownian motion process.
The main contributions are:
(1) the value of the implicit rent (service flow) is derived as a
function of the house price process instead of assumed to be constant,
as in prior research;
(2) the mean reverting model has additional factors that may help
forecast mortgage termination; and
(3) the house price process is shown to have a significant effect on
the value of a mortgage over a wide range of parameter values.
Chapter 3 presents a modeling framework for residential mortgages that
has separate models for each loan payment status (Current, 30 Days
Late, 60 Days Late, 90+ Days Late, in Foreclosure, in REO, or Paid
Off). It is shown that several classes of traditional mortgage
prepayment and default models are restricted forms of this model, and
that the restrictions are rejected empirically.
Dissertation by Ralph DeFranco (U.C. Berkeley) 1994 [PDF]
Posted by omor at 11:01 PM | Comments (0)
April 24, 2005
Option-Theoretic Prepayment Model for Mortgages: Fabozzi , Kalotay and Yang
A new approach for modeling the prepayments of a mortgage pool
shows how to value mortgage pools and agency mortgage-backed
securities. A notion of refinancing efficiency describes the
full spectrum of refinancing behavior.
The approach has two distinguishing features:
(1) The primary focus is on understanding the market value of a
mortgage, in contrast with standard models that strive (often
unsuccessfully) to predict future cash flows, and
(2) we use two separate yield curves, one for discounting mortgage
cash flows and the other for MBS cash flows.
An Option-Theoretic Prepayment Model for Mortgages and Mortgage-
Backed Securities
To appear in International Journal of Theoretical and Applied Finance
Dec 2004, jrg 7, nr 8, december 2004, pages 949-978.
[PDF]
Posted by omor at 01:24 PM | Comments (0)
March 27, 2005
Riskmetrics journals
Riskmetrics journals and old (1999-2002) Working Papers.
Posted by omor at 04:34 AM | Comments (0)
March 07, 2005
FIASI ads Three New Hall-of-Famers
In 2003 November, the Fixed Income Analysts Society tipped its hat to
three leading lights in the fixed-income arena, inducting Frank J.
Fabozzi, Abner D. Goldstine and Oldrich A. Vasicek into its Hall of
Fame. The eighth annual awards ceremony recognized the trio for their
contributions to the advancement of fixed-income analysis and
portfolio management. Previous Hall of Famers include Martin
Leibowitz, Fischer Black, John C. Bogle and William H. Gross.
Fabozzi, of course, is a name on everyone’s lips. He single-handedly
created and stocked a library of books on fixed-income education
where nothing of the kind existed, helping school many thousands of
individuals in the theory and business of the debt markets. Goldstine
is an innovator in the creation of bond portfolios for investors.
Vasicek is a fixed-income modeler who opened up new avenues in
interest rate derivatives and credit modeling.
Nina Mehta, Financial Engineering News.
Posted by omor at 10:05 PM | Comments (0)