Risk magazine/Technical paper

Gamma loss and prepayment

Peter Jackel presents a model for the dynamics of fractional notional losses and prepayments on asset-backed securities for the valuation and risk management of derivatives, including waterfall structures and other structured debt obligations on bespoke…

Let's jump together: pricing credit derivatives

Joao Garcia, Serge Goossens and Wim Schoutens introduce a dynamic multivariate jump-driven model for credit spreads. The model parameters come from a calibration on swaptions and a correlation-matching procedure. The authors apply the model to credit…

A free lunch and the credit crunch

Monoline insurers act as triple-A guarantors of the senior risks in structured finance. A purchaser of credit insurance or protection from a monoline may argue that they take only a small amount of the counterparty risk that is a common side-effect of…

Estimating credit contagion in a standard factor model

State-of-the-art credit risk portfolio models and the new Basel capital Accord consider only symmetric dependencies between borrowers in a portfolio, such as correlations. Recently, asymmetric dependencies have been introduced by Davis & Lo (2001), among…

Explaining the Levy base correlation smile

Joao Garcia and Serge Goossens look at base expected loss at maturity both in the Gaussian copula and Levy-based models, and link it to base correlation in these frameworks. They report on the existence of smile in both base correlation curves and…

Inflation is normal

Chris Kenyon introduces normal-based smile models for year-on-year inflation motivated by the observation that market lognormal caplet volatilities of less than 1% imply normality for maturities of up to 30 years. He is also motivated by the range of…

Estimating intrinsic currency values

Forex market practitioners constantly talk about the strengthening or weakening of individual currencies. In this article, Jian Chen and Paul Doust present a new methodology to quantify these statements in a manner that is consistent with forex market…

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…

A trick of the credit tail

Leveraged super-senior (LSS) trades represent a mechanism for packaging senior credit risk. Many LSS structures have been issued to date and yet there seems to be no formal pricing approach. In this article, Jon Gregory discusses the valuation of LSS…

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…

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…

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…

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…

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