Interest rate models with Markov chains

Imperial Users onl

Pricing Models for Bermudan-Style Interest Rate Derivatives

Bermuda-stijl rente derivaten vormen een belangrijke klasse van opties. Veel bancaire en verzekeringsproducten, zoals hypotheken, vervroegd aflosbare obligaties, en levensverzekeringen, bevatten Bermuda rente opties, die een gevolg zijn van de mogelijkheid tot vervroegde terugbetaling of stopzetting van het contract. Het veel voorkomen van deze opties maakt duidelijk dat het belangrijk is, voor banken en verzekeraars, om de waarde en risico van deze producten op de juiste manier in te schatten. Het juist inschatten van het risico maakt het mogelijk om markt risico af te dekken met onderliggende en regelmatig verhandelde waardes en opties. Waarderingsmodellen moeten arbitrage-vrij zijn, en dienen gekalibreerd te zijn aan prijzen van actief verhandelde onderliggende opties. De dynamica van de modellen moet overeen komen met de geobserveerde dynamica van de rente-termijnstructuur, zoals bijvoorbeeld correlatie tussen rentestanden. Bovendien moeten waarderingsalgoritmes efficiënt zijn: Financiële beslissingen gebaseerd op derivaten waarderingsberekeningen worden veeleer binnen enkele seconden genomen, dan binnen uren of dagen. In recente jaren is een succesvolle klasse van modellen naar voren gekomen, genaamd markt modellen. Dit proefschrift breidt de theorie van markt modellen uit, door: (i) een nieuwe, efficiënte en meer nauwkeurige benaderende waarderingstechniek te introduceren, (ii) twee nieuwe en snelle algoritmes voor correlatie-kalibratie te presenteren, (iii) nieuwe modellen te ontwikkelen die een efficiënte kalibratie toestaan voor een hele nieuwe klasse van derivaten, zoals vaste-looptijd Bermuda rente opties, en (iv) nieuwe empirische vergelijkingen te presenteren van bestaande kalibratie technieken en modellen, in termen van reductie van risico.Bermudan-style interest rate derivatives are an important class of options. Many banking and insurance products, such as mortgages, cancellable bonds, and life insurance products, contain Bermudan interest rate options associated with early redemption or cancellation of the contract. The abundance of these options makes evident that their proper valuation and risk measurement are important to banks and insurance companies. Risk measurement allows for offsetting market risk by hedging with underlying liquidly traded assets and options. Pricing models must be arbitrage-free, and calibrated to prices of actively traded underlying options. Model dynamics need be consistent with observed dynamics of the term structure of interest rates, e.g., correlation. Moreover, valuation algorithms need be efficient: Derivatives pricing calculations need be performed in seconds, rather than hours or days. Recently, a successful class of models appeared in the literature known as market models. This thesis extends market model theory: (i) it introduces a new, efficient, and more accurate approximate pricing technique, (ii) it presents two new fast algorithms for correlation-calibration, (iii) it develops new models enabling efficient calibration for a new range of derivatives, such as fixed-maturity Bermudan swaptions, and (iv) it presents novel empirical comparisons of hedge performance of existing calibrations and models.Raoul Pietersz was born on 12 June 1978 in Rotterdam, The Netherlands. In 2000, he obtained a Certificate of Advanced Studies in Mathematics (Mathematical Tripos Part III), with distinction, from the University of Cambridge. Over the academic year 1999-2000, he was awarded a title of Cambridge European Trust Scholar, and a retrospective title of Scholar at Peterhouse, Cambridge. In the summer of 2000, he completed internships at UBS Warburg and Dresdner Kleinwort Wasserstein, in London. In 2001, he obtained a first class M.Sc. degree in Mathematics from Leiden University. His Master’s thesis entitled “The LIBOR market model”was completed during an internship at ABN AMRO Bank, in Amsterdam. Over the period 1997-2001, he was awarded the Shell International Scholarship for undergraduate studies. His Ph.D. research, under supervision of Antoon Pelsser and Ton Vorst, focuses on the efficient valuation and risk management of interest rate derivatives. He has published articles in The Journal of Computational Finance, The Journal of Derivatives, Quantitative Finance, Risk Magazine and Wilmott Magazine. He has presented his research at various international conferences. His teaching experience includes lecturing taught Master courses on derivatives at the Rotterdam School of Management. Since the start of the Ph.D. period, he has held a part-time position at ABN AMRO Bank, initially at Quantitative Risk Analytics, Risk Management. Since July 2004, he is a Senior Derivatives Researcher, developing front-office pricing models for interest rate derivatives, at Product Development Group, Quantitative Analytics, as part of Structured Derivatives

Brady Bonds and Other Emerging-Markets Bonds

Trading and Capital-Markets Activities Manual, section covering Brady bonds in emerging market countries

Essays on Asset Pricing with Financial Frictions

The rst essay focuses on Credit default swap (CDS) premiums of safe sovereigns, that is, the insurance against the default of countries with a low credit risk, like Germany, Japan, or the United States. We motivate the essay by establishing the following two stylized facts. First, we document that there is a large market for insurance against the default of safe sovereigns and that the CDS premiums for these sovereigns are substantial, sometimes exceeding 100 basis points. Second, we show that there is virtually no relationship between CDS premiums and bond yield spreads, which are measured as the spread between bond yield and risk-free rate, for safe sovereigns. This nding is in opposition to the no-arbitrage theory that CDS premiums and yield spreads should move in lockstep. Motivated by these stylized facts, we investigate the following two questions: First, what are the motives behind purchasing insurance against the default of safe sovereigns? Second, what drives safe-haven CDS premiums if not credit risk

New Tax Issues Arising From the Dodd-Frank Act and Related Changes to Market Practice for Derivatives

The Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") requires that most over-the-counter ("OTC") derivatives be cleared through a clearinghouse and traded on a regulated exchange. This article discusses a number of U.S. federal income tax issues raised by Dodd-Frank and related changes to market practice for derivatives. The article also provides background discussion on current market practice and the clearing process. The first question addressed by the article is the extent to which formerly-OTC derivatives traded on an exchange will become subject to the special mark-to-market rules of § 1256 that apply to other exchange-traded derivatives. Dodd-Frank partially addresses this issue through an amendment to § 1256 excluding certain types of OTC swaps from its scope. The article discusses a range of possible interpretations of this amendment and suggests some further amendments to the law that could alleviate pressure on the guidance process. The second set of tax issues addressed by this article are those stemming from the fact that the move towards regulated clearing and trading has the effect of increasing substantially the number of swaps that are entered into, or deemed entered into, with upfront payments, which may be treated under long-standing rules as giving rise to a deemed loan between the parties. The article explains the ambiguities of these rules, particularly with respect to centrally cleared swaps and in the case of credit default swaps, and suggests a number of changes to the law

Interest rate risk management : a case study of GBS Mutual Bank

Banks play a pivotal role in the economic growth and development of countries, primarily through the diversification of risk for both themselves and other economic agents. Interest rate risk is regarded as one of the most prominent financial risks faced by a bank. A large portion of private banks’ revenue stems from net interest income that is generated from the difference between various assets and liabilities that are held on the balance sheet. Fluctuations in the interest rate can alter a bank’s interest income and value, making interest rate risk management vital to its success. The asset and liability committee of a bank is the internal committee charged with the duty of managing the bank’s interest rate risk exposure through the use of various hedging strategies and instruments. This thesis uses a case study methodology to analyse GBS Mutual Bank interest rate risk management. Its specific business circumstances, balance sheet structure and the market conditions over a specified period are used to comment on the practicality of a variety of balance sheet positioning strategies and derivative hedging instruments. The thesis also provides recommendations for the bank’s asset and liability committee in terms of its functions and organisation. It is elucidated that the most practical balance sheet hedging strategies are a volume strategy and immunisation, while the most practical derivative hedging instruments are interest rate futures and interest rate collars. It is found that the bank has a well functioning asset and liability committee whose only encumbrance to its functionality is the inadequacy of the informational technology used to measure, control and manage its interest rate risk position. This thesis concludes by summarising the practicality of the various interest rate risk hedging alternatives available to the GBS Mutual Bank. Implementing a particular strategy or instrument depends, of course, on its asset and liability committee’s decision