Abstract:

We present three examples of credit products whose valuation poses challenging modeling problems related to armageddon scenarios and extreme losses, analyzing their behaviour pre- and in-crisis. The products are Credit Index Options (CIOs), Collateralized Debt Obligations (CDOs), and Credit Valuation Adjustment (CVA) related products. We show that poor mathematical treatment of possibly vanishing numeraires in CIOs and lack of modes in the tail of the loss distribution in CDOs may lead to inaccurate valuation, both pre- and especially in crisis. We also consider the limits of copula models in trying to represent systemic risk in credit intensity models. We finally enlarge the picture and comment on a number of common biases in the public perception of modeling in relationship with the crisis.

Abstract:

Traditional risk measures like Value-at Risk often imply a short holding period of the portfolio. These risk measures are sufficient if the open position of the portfolio can be closed during the holding period, e.g. for trading portfolios in liquid markets. For a substantial portfolio like the asset portfolio of an energy supplier the closing of the open position during a short time period is not always possible. The same problem occurs for portfolios in markets with limited liquidity, or for portfolios pursuing a given strategy. Calculating the absolute risk for such portfolios requires specific risk measures. Such a measure is the liquidity adjusted Value-at-Risk that is presented in this talk. The application of this risk measures for large energy portfolio will be discussed.

Abstract:

We present a quantitative description of the markets and models evolution across the credit crunch crisis. In particular, we focus on the fixed income market and we analyze the most relevant empirical evidences, regarding the divergences between Libor and OIS rates, the explosion of Basis Swaps spreads, and the diffusion of collateral agreements and CSA-discounting, in terms of credit and liquidity effects.

We then review the new modern pricing approach prevailing among practitioners, based on multiple yield curves reflecting the different credit and liquidity risk of Libor rates with different tenors and the overnight discounting of cash flows originated by derivative transactions under collateral with daily margination. In particular, we discuss the classical and modern no-arbitrage pricing formulas for plain vanilla interest rate derivatives and the multiple-curve generalization of the market standard SABR model with stochastic volatility. We also report the results of an empirical analysis on recent market data comparing pre- and post-credit crunch pricing methodologies and showing the transition of the market practice from the classical to the modern framework.

Finally, we discuss the present market transition towards CSA-discounting in terms of pricing, Trading, IT, Risk Management, Accounting and Management decisions.

Abstract:

The presentation will present an analysis of how the recent financial crisis has catalyzed longer-run shifts in the relationship between the State and markets as well as in the global balance of economic power. It will also assess current trends in key emerging markets, with a particular focus on potential pressure points in the future.

Abstract:

One of the difficulties in the quantification of operational risk in advanced measurement approaches (AMA) is the computation of the capital requirements for a given model. In the loss distribution approach the frequency and the severity of the individual losses are assumed to be independent. The aggregate yearly loss is simply a sum over the losses incurred during that year. It has been observed that in these aggregate losses a few events, often a single one, dominate in the sum. This is a consequence of the heavy tails in the severity distribution. This observation has prompted the use of formulas based on approximating the sum by its largest term. In this talk we review the single-loss approximation, introduced by Böcker and Klüppelberg in the area of operational risk measurement, and introduce corrections to this formula in a systematic manner. The application of these approximations to the quantification of diversification effects (aggregation across risk units) and reallocation of capital will also be discussed.

Abstract:

The recent financial crisis has highlighted the need for the industry to understand the complexity and interconnectedness of the over-the-counter derivatives markets, and to develop better approaches for accurately measuring, managing and mitigating Counterparty Credit Risk (CCR). In particular, the Basel Committee identified several areas where capital for CCR proved to be inadequate, and has revamped its treatment in Basel III. For instance, wrong-way risk was evident through the crisis and was not adequately incorporated into the framework. Also, mark-to-market losses due to credit valuation adjustments (CVA) were not directly capitalized, with roughly two-thirds of CCR losses due to CVA. Also, large financial institutions were more interconnected than previously modeled. In this paper, we discuss some of the challenges of implementing an effective measurement framework for CCR capital and CVA in the aftermath of the crisis and in the context of new Basel III regulation. We model and quantify the impact of wrong-way risk for exposures, CCR capital, CVA and CVA VaR, by explicitly modeling the correlation of exposures and credit events. Finally, we highlight the deficiencies of using stressed exposures, as explicitly required by the new regulation.