Quantitative analysis
Unified Asian pricing
Options
Testing assumptions
In calculating value-at-risk forecasts for trading portfolios, distributional assumptions are asimportant as the choice of risk factors, but it is not easy to determine the source of errorwhen rejected forecasts occur. Here, Jeremy Berkowitz develops a…
Substitute hedging
Derivatives on assets that are difficult to trade are of growing importance. Pricing suchderivatives requires the use of utility theory and proxy assets for hedging. Here, VickyHenderson and David Hobson review the theory and discuss several topical…
Universal Barriers
As our survey in this issue shows, there is an increasing volume of barrier products traded in the forex options market. Here, Alexander Lipton and William McGhee discuss the pricing of barriers under various model frameworks, with particular focus on…
Credit risk in asset securitisations: an analytical model
How much capital should banks reserve against investments in portfolio securitisations? Asserting that recent proposals on this subject by Basel are inconsistent, Michael Pykhtin and Ashish Dev propose a new analytical model suitable for tranches of…
At the end of the tail
When fat tails are present, extreme value theory provides a framework for estimating value-at-risk at higher confidence levels with greater accuracy than traditional Var methods. Naveen Andrews and Mark Thomas explain
Honour your contribution
What is the best method for determining the risk contribution of a component in a portfolio? An exploration of the pros and cons of three important methods, showing that none dominates the others.
Mean-reverting smiles
Commodity markets such as crude oil exhibit mean reversion as well as option smiles. The authors construct a model suitable for pricing exotic options in these markets
Exotic spectra
Eigenfunction expansions can also be applied to finance. The method is particularly suited to barrier and Asian options, with convergence properties that compare favourably with Monte Carlo.
Globalisation and equity index exposure
Equity diversification
Inside insider trading
Securities regulators need techniques to detect insider trading if it occurs and determine the extent of possible sanctions. Here, the author proposes a new probabilistic methodology particularly suited to illiquid markets.
New products, new risks
Structured equity products marketed in Europe present considerable risk management challenges. The author shows the danger of using naive model-based approaches to price and hedge them.
Globalisation and equity index exposure
Does the global presence of large multinational companies diminish the diversification effect inequity portfolios? Gary Robinson argues that this is indeed the case, and suggests a remedy
Analytical approach to credit risk modelling
The increasing popularity of VAR-based credit portfolio risk models has led to a growing recognition that Monte Carlo techniques are inadequate for economic capital calculations. Here, Michael Pykhtin and Ashish Dev present a new analytical alternative…
Himalaya options
Nothing epitomises the challenges of complex equity derivatives better than the so-called ‘mountain range’ products. In the second article looking at the challenges of this market, Marcus Overhaus analyses a particular product, the Himalayan option,…
The need for hybrid models
In response to the above article, the authors argue that pure firm-value approaches to default prediction are fundamentally flawed.?
Predictive Merton models
Do default indicators such as agency ratings improve upon the predictive power of KMV’s proprietary default prediction methodology?
Credit model evaluation
With the new Basel Capital Accord scheduled for implementation in 2005, banks are having to evaluate the credit scoring models that will enable them to meet the minimum standards for Basel’s internal ratings-based (IRB) approach. Selecting an appropriate…
Calibrating Libor
With a rich spectrum of maturities and tenors to contend with, the toughest aspect of pricing interest rate options is calibrating models of forward rates to market data. Here, Damiano Brigo and Fabio Mercurio present a scheme for simultaneously…
A discrete question
How should discrete dividend options be modelled in an equity option pricing framework? As Volf Frishling warns, unthinking use of certain models to solve this problem can lead tosignificant mispricing in some situations
Pricing default baskets
Nicholas Dunbar, Risk’s technical editor, introduces the first in a new series of technical papers written by quants at Deutsche Bank.“Default correlation has been one of the hottest topics in credit derivatives over the past year. So it is a pleasure to…
Basel II - Rules and Models
The proposed operational risk charge remains one of the most contentious areas of the new Basel Accord. Carol Alexander reviews the current proposals in the context of various simple models, and argues that practical implementation will require the use…
Linear, yet attractive, Contour
Banks’ Potential Future Exposure models are at the core of the advanced EAD (Exposure At Default) approach to capital requirements for credit risk considered in the New Basel Capital Accord. Juan Cárdenas, Emmanuel Fruchard and Jean-François Picron look…
Emerging markets ramp up
Asset and liability management systems sales continue to be strong in the US and Europe, thanks to Basel II preparations. But it is in the emerging markets that vendors say strong sales growth will come in 2002.