Quantitative analysis
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,…
Vix option pricing in a jump-diffusion model
Artur Sepp discusses Vix futures and options and shows that their market prices exhibit positive volatility skew. To better model the market behaviour of the S&P 500 index and its associated volatility skew, he introduces the stochastic dynamics of the…
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…
Modelling default rate in a retail portfolio and the estimation of portfolio risk
Considering correlation as the major driving factor for portfolio risk, Farshad Mashayekhi and Joy Wang present a methodology for the estimation of correlation among retail exposures based on historical default rates in pools of retail accounts. The…
Geometric mean variance
It is argued that a constrained mean variance framework is superior to Black-Litterman asset allocation, and can help an investor determine the mean excess return vector given their market views
Confidence intervals for corporate default rates
Rating agency default studies provide estimates of mean default rates over multiple time horizons but have never included estimates of the standard errors of the estimates. This is due at least in part to the challenge of accounting for the high degree…
A trick of the credit tail
Credit derivatives
Interest rate risk of mortgage servicing rights
Dick Boswinkel and Kent Westerbeck examine the behaviour of mortgage servicing rights' duration and convexity and explain how they relate to the prepayment assumptions used in valuing MSRs
Future mortality improvements in the ^G7 countries
Technical papers
The determinants of corporate credit spreads
Credit default swaps (CDSs) are an integral tool used for the management of credit risk by financial institutions. Despite their importance, good models for the determination of CDS spreads, also called corporate credit spreads, are not readily available…
Factor models for credit correlation
Stewart Inglis and Alex Lipton describe dynamic and static factor models for credit correlation, and show how the static model can be calibrated to the market and used for the pricing of standard and bespoke tranches, including tranchelets
Cash-settled swaptions and no-arbitrage
Brief Communication
Geometric mean variance
Asset Allocation
Counterparty risk and CCDSs under correlation
Hybrid Products
Calibration of CDO tranches with the dynamical GPL model
Consistent calibration of a credit index and its tranches across maturities with a single arbitrage-free model is a difficult problem. Here, Damiano Brigo, Andrea Pallavicini and Roberto Torresetti show that a simple loss dynamics based on the…