Technical papers/Derivatives
Quadratic Gaussian inflation
Quadratic Gaussian models are particularly amenable to analytic solutions, and so have become popular for rates modelling. Here, Manlio Trovato, Diana Ribeiro and Hringur Gretarsson extend the approach...
Luca Capriotti and Michael Giles show how algorithmic differentiation can be used to systematically implement the adjoint calculation of sensitivities in Monte Carlo for general path-dependent and multi-asset...
Latent variable models of default are used extensively both in internal credit rating methodologies and in the pricing of exotic credit derivatives. But, as Rüdiger Frey, Alexander McNeil and Mark Nyfeler...
Using market and credit risk analytics to strengthen performance
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More Technical papers/Derivatives articles
Cooking with collateral
In the wake of the crisis, the traditional assumption of a risk-free counterparty and rate has been shown to be false, yet it still underpins finance theory. Vladimir Piterbarg develops theoretical foundations for a model of an economy without a risk-free...
Cutting Edge introduction: The origins of the standardised CVA charge
Regulators are attempting to narrow the gap between regulatory capital formulas and banks’ internal models – but recent work in the area of the controversial credit value adjustment demonstrates just how far apart they remain. Laurie Carver introduces...
Quanto adjustments in the presence of stochastic volatility
It is well known that the quanto adjustment in the drift of the underlying has a significant impact on the prices of quanto options. Alexander Giese points out that an additional quanto adjustment in the underlying’s volatility needs to be considered...
An easy-to-hedge covariance swap
Covariance swaps that track the covariance of assets can be difficult to hedge because there is no known static replication formula, unlike the case for variance swaps. However, in the case of swaps measuring the covariance between the absolute returns...
Quanto adjustments in the presence of stochastic volatility
It is well known that the quanto adjustment in the drift of the underlying has a significant impact on the prices of quanto options. Alexander Giese points out that an additional quanto adjustment in the underlying’s volatility needs to be considered...
Stochastic volatility’s orderly smiles
Lorenzo Bergomi and Julien Guyon derive an expansion of the volatility surface of general stochastic volatility models at second order in volatility of volatility that is accurate for a wide range of strikes. They characterise the shape of stochastic...
Valuation of commodity structures in co-integrated futures markets
In this paper, Dan Mahoney and Krzysztof Wolyniec show that in co-integrated (mean-reverting) futures markets, active dynamic hedging is required to realise the quadratic variation of the underlying spread process. Using static hedges/portfolios yields...
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