635 research outputs found
Consistent Valuation Across Curves Using Pricing Kernels
The general problem of asset pricing when the discount rate differs from the
rate at which an asset's cash flows accrue is considered. A pricing kernel
framework is used to model an economy that is segmented into distinct markets,
each identified by a yield curve having its own market, credit and liquidity
risk characteristics. The proposed framework precludes arbitrage within each
market, while the definition of a curve-conversion factor process links all
markets in a consistent arbitrage-free manner. A pricing formula is then
derived, referred to as the across-curve pricing formula, which enables
consistent valuation and hedging of financial instruments across curves (and
markets). As a natural application, a consistent multi-curve framework is
formulated for emerging and developed inter-bank swap markets, which highlights
an important dual feature of the curve-conversion factor process. Given this
multi-curve framework, existing multi-curve approaches based on HJM and
rational pricing kernel models are recovered, reviewed and generalised, and
single-curve models extended. In another application, inflation-linked,
currency-based, and fixed-income hybrid securities are shown to be consistently
valued using the across-curve valuation method.Comment: 56 page
An intertemporally-consistent and arbitrage-free version of the Nelson and Siegel class of yield curve models
This article derives a generic, intertemporally-consistent, and arbitrage-free version of the popular class of yield curve models originally introduced by Nelson and Siegel (1987). The derived model has a theoretical foundation (conferred via the Heath, Jarrow and Morton (1992) framework) that allows it to be used in applications that involve an implicit or explicit time-series context. As an example of the potentialapplication of the model, the intertemporal consistency is exploited to derive a theoretical time-series process that may be used to forecast the yield curve. The empirical application of the forecasting framework to United States data results in out-of-sample forecasts that outperform the random walk over a sample period of almost 50 years, for forecast horizons ranging from six months to three years
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Modelling the fair value of annuities contracts: the impact of interest rate risk and mortality risk
The purpose of this paper is to analyze the problem of the fair valuation of annuities contracts. The market consistent valuation of these products requires a pricing framework which includes the two main sources of risk affecting the value of the annuity, i.e. interest rate risk and mortality risk. As the IASB has not set any specific guidelines as to which models are the most appropriate for these risks, in this note we consider a range of different models calibrated with historical data. We calculate the fair value of the annuity as a portfolio of zero coupon bonds, each with maturity set equal to the date of the annuity payments; the weights in the portfolio are given by the survival probabilities. Moreover, we focus on the additional information provided by stochastic simulations in order to define a suitable risk margin. The nature of the risk margin is one of the main key issues concerning the IASB and Solvency project
Markov Functional Market Model nd Standard Market Model
The introduction of so called Market Models (BGM) in 1990s has developed
the world of interest rate modelling into a fresh period. The obvious
advantages of the market model have generated a vast amount of research
on the market model and recently a new model, called Markov functional
market model, has been developed and is becoming increasingly popular.
To be clearer between them, the former is called standard market model
in this paper.
Both standard market models and Markov functional market models are
practically popular and the aim here is to explain theoretically how each
of them works in practice. Particularly, implementation of the standard
market model has to rely on advanced numerical techniques since Monte
Carlo simulation does not work well on path-dependent derivatives. This
is where the strength of the Longstaff-Schwartz algorithm comes in. The
successful application of the Longstaff-Schwartz algorithm with the standard
market model, more or less, adds another weight to the fact that the
Longstaff-Schwartz algorithm is extensively applied in practice
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