2000 Series

OTC Derivatives for Retail Investors: The Case of Equity Linked Saving

Reference: 2000-11
Authors: Harry Kat

Abstract: In this paper we report on a new class of derivative products which we refer to as equity-linked savings products. Equity-linked savings products require investors to pay periodic instalments in return for a predefined equity-linked payoff at maturity. We discuss the structuring, hedging, pricing and marketing of a variety of equity-linked savings products in detail, paying particular attention toContinue reading

Principal Component Analysis of Implies Volatility Smiles and Skews

Reference: 2000-10
Authors: Carol Alexander

Abstract: Several principal component models of volatility smiles and skews have been based on daily changes in implied volatilities, by strike and/or by moneyness. Derman and Kamal (1997) analyze S&P500 and Nikkei 225 index options where the daily change in the volatility surface is specified by delta and maturity. Skiadopoulos, Hodges and Clewlow (1998) apply PCA to first differences ofContinue reading

On Modelling, Credit Risk Using Arbitrage Free Models

Reference: 2000-08
Authors: Frank Skinner, Antonio Diaz

Abstract: By examining the distribution of state prices obtained from binomial versions of Jarrow and Turnbull (1995), Lando (1998) and Duffie and Singleton (1999), we are able to suggest which credit risk parameters are of critical interest. We find that it appears worthwhile to parameterize credit risk since even the simplest parameterized model obtains large changes in the distribution ofContinue reading

An Extreme Value Theory Approach to Calculating Minimum Risk Capital Requirements

Reference: 2000-07
Authors: Chris Brooks, Andrew Clare, Gita Persand

Abstract: This paper investigates the frequency of extreme events for three LIFFE futures contracts for the calculation of minimum capital risk requirements (MCRRs). We propose a semi-parametric approach where the tails are modelled by the Generalised Pareto Distribution and smaller risks are captured by the empirical distribution function. We compare the capital requirements from this approach with those calculated fromContinue reading

Orthogonal Methods for Generating Large Positive Semi-Definite Covariance Matrices

Reference: 2000-06
Authors: Carol Alexander

Abstract: It is a common problem in risk management today that risk measures and pricing models are being applied to a very large set of scenarios based on movements in all possible risk factors. The dimensions are so large that the computations become extremely slow and cumbersome, so it is quite common that over-simplistic assumptions will be made. In particular,Continue reading

The ACD Model: Predictability of the Time Between Consecutive Trades

Reference: 2000-05
Authors: Alfonso Dufour, Robert F. Engle

Abstract: Forecasting ability of several parameterizations of ACD models are compared to benchmark linear autoregressions for inter-trade durations. The estimation of parametric ACD models requires both the choice of a conditional density for durations and the specification of a functional form for the conditional mean duration. Our results provide guidance for choosing among different parameterizations and for developing better forecastingContinue reading

Economic Activity and Time Variation in Expected Futures Returns

Reference: 2000-03
Authors: Joelle Miffre

Abstract: This article studies the link between the predictability of futures returns and the business cycle. Modelling the relationship between the variation through time in expected futures returns and economic activity should give us some insight as to whether the predictable movements in futures returns result from rational variation in the returns required by investors over time. With this inContinue reading

Measuring Operational Risks with Bayesian Belief Networks

Reference: 2000-02
Authors: Carol Alexander

Abstract: The likely imposition by regulators of minimum standards for capital to cover ‘other risks’ has been a driving force behind the recent interest in operational risk management. Much discussion has been centered on the form of capital charges for other risks. At the same time major banks are developing models to improve internal management of operational processes, new insuranceContinue reading

Value At Risk and Market Crashes

Reference: 2000-01
Authors: Chris Brooks, Gita Persand

Abstract: Many popular techniques for determining a securities firm’s value at risk are based upon the calculation of the historical volatility of returns to the assets that comprise the portfolio, and of the correlations between them. One such approach is the J.P. Morgan RiskMetrics methodology using Markowitz portfolio theory. An implicit assumption underlying this methodology is that the volatilities andContinue reading