Cutting Edge

Unifying volatility models

This article introduces a method for building analytically tractable option pricing models that combine state-dependent volatility, stochastic volatility and jumps. The eigenfunction expansion method is used to add jumps and stochastic volatility to…

Multi-factor adjustment

The author presents an analytical method for calculating portfolio value-at-risk and expected shortfall in the multi-factor Merton framework. This method is essentially an extension of the granularity adjustment technique to a new dimension.

Swap vega in BGM: pitfalls and alternatives

Raoul Pietersz and Antoon PelsserPractitioners who are developing the Libor BGM model for risk management of a swap-based interest rate derivative be warned: for certain volatility functions the estimate of swap vega may be poor. This may occur for time…

Corridor variance swaps

This article studies a recent variation of a variance swap called a corridor variance swap (CVS). For this swap, returns are not counted in the realised variance calculation if the reference index level is outside some specified corridor. CVSs allow…

What’s a basket worth?

Peter Laurence and Tai-Ho Wang take a significant step in the valuation of basket options with positive and fixed weights. These model all index options, price, cap or equal weighted. Departing from the usual Black-Scholes framework, the authors provide…

’Tis the season...

Abstract: Aurelian Tröndle presents a general framework for modelling prices of storable and non-storableenergy assets, which sheds light on different market fundamentals, and showshow energy market volatility is seasonal and anything but stable. The…

Bringing credit portfolio modelling to maturity

Michael Barco shows how to perform mark-to-market credit portfolio modelling by extending the well-known saddle-point technique, introducing spread and recovery rate volatility. He then tests his results on a fictitious portfolio, showing how asset…

Calculating transfer risk using Monte Carlo

Marco van der Burgt constructs a model of emerging market transfer risk based on a country’s foreign exchange reserves that is combined with facility-dependent risk factors that determine counterparty exposure in the event of a moratorium. He then…

All your hedges in one basket

Leif Andersen, Jakob Sidenius and Susanta Basu present new techniques for single-tranche CDO sensitivity and hedge ratio calculations. Using factorisation of the copula correlation matrix, discretisation of the conditional loss distribution followed by a…

Using the grouped t-copula

Student-t copula models are popular, but can be over-simplistic when used to describe credit portfolios where the risk factors are numerous or dissimilar. Here, Stéphane Daul, Enrico De Giorgi, Filip Lindskog and Alexander McNeil construct a new,…

Benchmarking asset correlations

Basel II stipulates that the asset correlation to be used in calibration of obligor risk weights is 20%. Here, Alfred Hamerle, Thilo Liebig and Daniel Rösch use a parametric model to empirically obtain asset correlations from a large database of…

Modelling venture capital funds

Modelling venture capital funds is a challenge and has become more important due to recentand upcoming securitisation deals, the need for efficient portfolio management, and Basel II.Here, Thomas Meyer and Tom Weidig summarise the issues both industry…

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