Technical papers - Risk.net

Cutting Edge introduction: risky contributions

Mon, 06 Feb 2012 16:53:01 GMT

Risky contributions Value-at-risk is usually calculated via Monte Carlo simulation, making it difficult to see the contributions from different risks. But in some circumstances approximate formulas can be derived that greatly save computing power – and explicitly show the sources of risk. Laurie Carver introduces this month’s technical articles

Perturbed Gaussian copula: introducing the skew effect in co-dependence

Tue, 31 Jan 2012 16:23:00 GMT

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Gaussian copula models are often used in the industry when single-asset information is quoted but little is known about their joint relation. These models may arise from correlated stochastic Brownian processes with deterministic volatility and correlation. If stochastic volatility is introduced, skewness and fat tails can be included in the co-dependence but analytic tractability is lost. Alberto Elices and Jean-Pierre Fouque show how this analytic tractability is preserved through another copula derived from an asymptotic expansion of the correlated processes with stochastic volatility around the Gaussian copula case

Conversion of upfront CVA into running CVA

Tue, 31 Jan 2012 11:27:37 GMT

Risk.net

Conversion of upfront CVA into running CVA The credit value adjustment that crystallises counterparty risk in a derivatives price is generally thought of as an upfront payment, but could equally well be converted into a running premium in appropriate products. But the obvious ways to do this lead to inconsistencies, or are computationally burdensome. Here, Frédéric Vrins and Jon Gregory show how an analytic approximation can get round this

Hybrid correlation matrices

Wed, 25 Jan 2012 17:20:00 GMT

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Hybrid correlation matrices Integrating available implied volatility data into a historical correlation matrix is an essential part of calibrating a Monte Carlo credit value adjustment pricing simulation at the portfolio level, but can yield nonsensical results. Someshwar Roy and Ersel Korusoy use principal components analysis and implied time series to ensure the output conforms to the properties of a correlation matrix

Analytical risk contributions for non-linear portfolios

Wed, 25 Jan 2012 17:20:00 GMT

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Analytical risk contributions for non-linear portfolios The value-at-risk of portfolios needs to account for non-linear effects in the loss distribution’s dependence on risk factors. Using the classical Cornish-Fisher expansion, Helmut Lutz and Carsten Wehn derive analytical formulas for risk contributions to the VAR by applying the Euler principle that aid capital allocation across sub-portfolios, and save computing time and data volume in comparison with a traditional Monte Carlo approach

Option strategies based on semiparametric implied volatility surface prediction

Wed, 11 Jan 2012 14:33:00 GMT

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Constructing the best trading strategy: a new general framework

Wed, 11 Jan 2012 14:32:00 GMT

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On a multi-timescale statistical feedback model for volatility fluctuations

Wed, 11 Jan 2012 14:30:00 GMT

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Perspectives on systemic risk

Wed, 11 Jan 2012 14:29:00 GMT

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Cutting edge introduction: requiem for a probabilist

Tue, 10 Jan 2012 15:46:46 GMT

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Requiem for a probabilist The already challenging task of calibrating stochastic volatility models becomes even more complex when rates are random too. But an efficient Monte Carlo approach can be found – by using an esoteric, but neglected, stochastic calculus. Laurie Carver introduces this month’s technical papers

Cutting Edge introduction: requiem for a probabilist

Tue, 10 Jan 2012 15:46:00 GMT

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A historical-parametric hybrid VAR

Tue, 10 Jan 2012 11:59:00 GMT

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A historical-parametric hybrid VAR

Perturbed Gaussian copula: introducing the skew effect in the co-dependence

Fri, 06 Jan 2012 10:02:38 GMT

Risk.net

Perturbed Gaussian copula: introducing the skew effect in the co-dependence Gaussian copula models are often used in the industry when single-asset information is quoted but little is known about their joint relation. These models may arise from correlated stochastic Brownian processes with deterministic volatility and correlation. If stochastic volatility is introduced, skewness and fat tails can be included in the co-dependence but analytic tractability is lost. Alberto Elices and Jean-Pierre Fouque show how this analytic tractability is preserved through another copula derived from an asymptotic expansion of the correlated processes with stochastic volatility around the Gaussian copula case

Perturbed Gaussian copula: introducing the skew effect in co-dependence

Fri, 06 Jan 2012 10:02:00 GMT

Risk.net

Perturbed Gaussian copula: introducing the skew effect in co-dependence Gaussian copula models are often used in the industry when single-asset information is quoted but little is known about their joint relation. These models may arise from correlated stochastic Brownian processes with deterministic volatility and correlation. If stochastic volatility is introduced, skewness and fat tails can be included in the co-dependence but analytic tractability is lost. Alberto Elices and Jean-Pierre Fouque show how this analytic tractability is preserved through another copula derived from an asymptotic expansion of the correlated processes with stochastic volatility around the Gaussian copula case

Being particular about calibration

Fri, 06 Jan 2012 07:49:46 GMT

Risk.net

Being particular about calibration Following previous work on the calibration of multi-factor local stochastic volatility models to market smiles, Julien Guyon and Pierre Henry-Labordère show how to calibrate exactly any such model. Their approach, based on McKean’s particle method, extends to hybrid models, where interest rates are also stochastic. They illustrate the efficiency of their algorithm on hybrid local stochastic volatility models

Cutting Edge introduction: clarity needed on credit adjustments

Thu, 08 Dec 2011 19:17:00 GMT

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Credit and credibility A debate over whether to include counterparty risk adjustments at the point of default is animating quants, but either of the obvious answers could exacerbate systemic risk. Laurie Carver introduces this month’s technical papers

Cutting Edge: the year of CVA

Thu, 08 Dec 2011 19:14:00 GMT

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The year of CVA With derivatives counterparty risk rocketing up the agenda this year, researchers have tried to shed some light on the associated challenges - from capital calculation to pricing - as the annual round-up of Risk's technical papers and citations shows. By Laurie Carver

Close-out convention tensions

Thu, 08 Dec 2011 12:50:00 GMT

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Close-out convention tensions There is an ambiguity in the market about the convention for valuing a derivative’s close-out value to be settled at default – in particular whether or not to include adjustments for the credit risk of the surviving party. Damiano Brigo and Massimo Morini show how to include these adjustments and take seriously the differences in the convention choice – and find that while the risk-free close-out can exacerbate contagion by increasing debtors’ liabilities, in highly correlated environments the risky close-out can dramatically lower the recovery received by creditors

A historical-parametric hybrid VAR

Thu, 08 Dec 2011 12:49:47 GMT

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A historical-parametric hybrid VAR The calculation of value-at-risk by historical simulation suffers increasingly from the problem of missing market data as the number of time series being included grows. This problem therefore tends to be particularly severe when VAR is used for calculating specific risk. Robin Stuart shows how the familiar methods of historical simulation and parametric VAR can be combined to produce a new hybrid VAR possessing some of the best features of both and capable of addressing the problem of incomplete data analytically

Sponsor covenants in risk-based capital

Mon, 05 Dec 2011 14:46:00 GMT

Risk.net

Sponsor covenants in risk-based capital With a second European Union consultation on moving pension fund capital requirements on to a more market-consistent, risk-based capital framework, many have been alarmed at the idea of heavy Solvency II-style requirements for retirement schemes. But incorporating covenant agreements as an embedded option on a fund’s liabilities can reduce the capital burden. By Malcolm Kemp

Funding cost adjustments for derivatives

Tue, 15 Nov 2011 12:45:38 GMT

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Funding cost adjustments for derivatives A paper discussing the relationship of the funding cost adjustment to the balance sheet and demonstrating two ways in which the funding cost adjustment can be eliminated

Cutting edge: valuing and dynamically hedging natural gas storage

Tue, 08 Nov 2011 12:38:00 GMT

Risk.net

Hedging the extrinsic value of a natural gas storage Natural gas storages are integral parts of gas distribution systems and play a key role in managing demand variations. Risk managers need to value storages on a daily basis, while traders face the challenge of effectively hedging storages. Ali Sadeghi presents a review of the basket-of-options approach for valuation and dynamically hedging the extrinsic value of a natural gas storage. The issue of market parameters and their impact on hedging efficiency is also discussed in detail

Cutting Edge introduction

Wed, 02 Nov 2011 15:19:57 GMT

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The DVA debate Banks profiting from a widening of their own credit spreads is causing more scrutiny of the debit value adjustment, with some viewing it as an accounting trick and others arguing it is a fact of life, however counter-intuitive it might seem. Laurie Carver introduces this month’s technical articles

Risk.net

Market-consistent equity risk premiums

Mon, 31 Oct 2011 17:36:00 GMT

Risk.net

The capital asset pricing model used to determine excess return for a given risk level and allocate assets typically uses historical data, which can be a poor predictor of risk. By adapting the model to be consistent with market-implied distributions, the market price of risk can be calculated in a forward-looking way. By Adrian Alscher and Angus Graham