Market consistency: model calibration in imperfect markets
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| Main Author: | |
|---|---|
| Format: | Book |
| Language: | English |
| Published: |
Chichester
Wiley
2009
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| Series: | Wiley finance series
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| Subjects: | |
| Online Access: | Inhaltsverzeichnis |
| Item Description: | Includes bibliographical references and index |
| Physical Description: | XXV, 350 S. graph. Darst. 26 cm |
| ISBN: | 9780470770887 0470770880 |
Staff View
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| 245 | 1 | 0 | |a Market consistency |b model calibration in imperfect markets |c Malcolm H. D. Kemp |
| 264 | 1 | |a Chichester |b Wiley |c 2009 | |
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Record in the Search Index
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| adam_text | Titel: Market consistency
Autor: Kemp, Malcolm H. D.
Jahr: 2009
Contents
Preface xiii
Acknowledgements xvii
Abbreviations xix
Notation xxiii
1 Introduction 1
1.1 Market consistency 1
1.2 The primacy of the market 2
1.3 Calibrating to the market 3
1.4 Structure of the book 3
1.5 Terminology 5
2 When is and when isn t Market Consistency Appropriate? 9
2.1 Introduction 9
2.2 Drawing lessons from the characteristics of money itself 9
2.2.1 The concept of value 9
2.2.2 The time value of money 10
2.2.3 Axioms of additivity, scalability and uniqueness 11
2.2.4 Market consistent valuations 13
2.2.5 Should financial practitioners always use market consistent
valuations? 14
2.2.6 Equity between parties 15
2.2.7 Embedded values and franchise values 16
2.2.8 Solvency calculations 17
2.2.9 Pension fund valuations 19
2.2.10 Bid-offer spreads 19
2.3 Regulatory drivers favouring market consistent valuations 20
2.4 Underlying theoretical attractions of market consistent valuations 22
2.5 Reasons why some people reject market consistency 23
2.6 Market making versus position taking 24
Contents
2.7 Contracts that include discretionary elements 25
2.8 Valuation and regulation 25
2.9 Marking-to-market versus marking-to-model 28
2.10 Rational behaviour? 30
Different Meanings given to Market Consistent Valuations 33
3.1 Introduction 33
3.2 The underlying purpose of a valuation 33
3.3 The importance of the marginal trade 33
3.4 Different definitions used by different standards setters 35
3.4.1 Introduction 35
3.4.2 US accounting-FAS 157 35
3.4.3 Guidance on how to interpret FAS, IAS, IFRS, etc. 36
3.4.4 EU insurance regulation - Solvency IT 37
3.4.5 Market consistent embedded values 42
3.4.6 UK pension fund accounting and solvency computation 42
3.5 Interpretations used by other commentators 43
3.5.1 Introduction 43
3.5.2 Contrasting market consistent values with real world values 43
3.5.3 Stressing the aim of avoiding subjectivity where possible 46
3.5.4 Extending market consistency to other activities 47
3.5.5 Application only if obvious market observables exist 47
3.5.6 Hedgeable liabilities 48
3.5.7 Fair valuation in an asset management context 49
Derivative Pricing Theory 51
4.1 Introduction 51
4.2 The principle of no arbitrage 52
4.2.1 No arbitrage 52
4.2.2 Valuation of symmetric derivatives 56
4.2.3 Valuation of asymmetric derivatives 61
4.2.4 Valuation of path dependent derivatives 63
4.3 Lattices, martingales and fto calculus 64
4.3.1 Lattice valuation approaches 64
4.3.2 Stochastic (Ito) calculus 70
4.3.3 The martingale formulation 75
4.3.4 Hedging 76
4.3.5 Path dependent derivatives 80
4.4 Calibration of pricing algorithms 81
4.4.1 Market conventions versus underlying market beliefs 81
4.4.2 Why calculate market implied parameters such as implied
volatility? 83
4.4.3 The volatility smile or skew 84
4.5 Jumps, stochastic volatility and market frictions 85
4.5.1 Mileage options 85
4.5.2 Jump processes 86
4.5.3 Stochastic volatility 88
Contents
4.5.4 Non-zero dealing costs 89
4.5.5 Interpretation in the context of Modem Portfolio Theory 90
4.6 Equity, commodity and currency derivatives 91
4.7 Interest rate derivatives 92
4.8 Credit derivatives 93
4.9 Volatility derivatives 95
4.10 Hybrid instruments 96
4.11 Monte Carlo techniques 97
4.12 Weighted Monte Carlo and analytical analogues 98
4.12.1 Weighted Monte Carlo 98
4.12.2 Analytical weighted Monte Carlo 99
4.13 Further comments on calibration 101
The Risk-free Rate 103
5.1 Introduction 103
5.2 What do we mean by risk-free ? 103
5.3 Choosing between possible meanings of risk-free 115
5.3.1 Real world or market consistent? 115
5.3.2 Choice between different reference rates 115
5.3.3 How risk-free is government debt? 120
5.3.4 Impact of choice of reference rate 124
Liquidity Theory 127
6.1 Introduction 127
6.2 Market experience 127
6.3 Lessons to draw from market experience 130
6.3.1 Consideration of extreme events 130
6.3.2 Or maybe not such extreme events? 131
6.3.3 Contagion 132
6.4 General principles 133
6.5 Exactly what is liquidity? 134
6.5.1 Different points of view 134
6.5.2 Funding versus market liquidity 136
6.5.3 The impact of these different points of view 137
6.5.4 Modelling liquidity premia on different instruments 138
6.6 Liquidity of pooled funds 139
6.7 Losing control 141
Risk Measurement Theory 145
7.1 Introduction 145
7.2 Instrument-specific risk measures 145
7.3 Portfolio risk measures 148
7.3.1 Introduction 148
7.3.2 Ex-post (i.e. historic, backward-looking, retrospective)
risk measures 150
7.3.3 Ex-ante (i.e. forward-looking, prospective) risk measures 153
Contents
7.4 Time series-based risk models 157
7.4.1 Risk models versus risk systems 157
7.4.2 Mathematical characterisation of different types of risk model 157
7.4.3 Intrinsic ways of estimating risk models from past data 158
7.4.4 Matrix analysis 159
7.4.5 The link back to pricing algorithms 161
7.4.6 Choice of underlying distributional form 161
7.4.7 Monte Carlo methods 164
7.4.8 Summary 164
7.5 Inherent data limitations applicable to time series-based risk models 164
7.5.1 The sparsity of the data available 164
7.5.2 Idiosyncratic risk 166
7.6 Credit risk modelling 167
7.6.1 Introduction 167
7.6.2 Credit ratings 168
7.6.3 Market consistency 170
7.6.4 Collateralised debt obligations (CDOs) 170
7.6.5 An accident waiting to happen? 175
7.6.6 Conduits and structured investment vehicles (SIVs) 176
7.7 Risk attribution 176
7.7.1 Intrinsic rationale 176
7.7.2 Traditional (covariance-based) risk attribution 177
7.7.3 Risk attribution applied to other types of risk measure 178
7.7.4 Stand-alone risk statistics 178
7.8 Stress testing 179
7.8.1 Introduction 179
7.8.2 Different interpretations 180
7.8.3 Further comments 183
185
185
186
189
189
190
192
193
194
194
195
195
197
198
200
200
202
Capital Adequacy
8.1 Introduction
8.2 Financial stability
8.3 Banking
8.3.1 The Basel Accords
8.3.2 Market risk
8.3.3 Credit risk
8.3.4 Operational risk
8.4 Insurance
8.4.1 Solvency II
8.4.2 Underlying approach
8.4.3 Best estimate calculations
8.4.4 Surrender rates
8.4.5 UK regulatory capital computations for insurers
8.4.6 Categorising risks
8.5 Pension funds
8.6 Different types of capital
Contents
9 Calibrating Risk Statistics to Perceived Real World Distributions 205
9.1 Introduction 205
9.2 Referring to market values 207
9.3 Backtesting 209
9.3.1 Introduction 209
9.3.2 In-sample versus out-of-sample backtesting 210
9.3.3 Testing backtest quality statistically 211
9.3.4 Intra-period position movements 213
9.3.5 Calibration of credit default models 213
9.4 Fitting observed distributional forms 213
9.5 Fat-tailed behaviour in individual return series 215
9.5.1 Identifying the true underlying return series 215
9.5.2 Fat tails 215
9.5.3 Skew, kurtosis and the (fourth-moment) Cornish-Fisher approach 220
9.5.4 Weaknesses of the Cornish-Fisher approach 221
9.5.5 Improving on the Cornish-Fisher approach 223
9.5.6 Time-varying volatility 224
9.5.7 Crowded trades 226
9.5.8 Bounded rationality 227
9.6 Fat-tailed behaviour in multiple return series 227
9.6.1 Introduction 227
9.6.2 Visualising fat tails in multiple return series 228
9.6.3 Copulas, Sklar s theorem and quantiles 230
9.6.4 Fractile-fractile (i.e. quantile-quantile box) plots 233
9.6.5 Time-varying volatility 236
9.6.6 Differentiating between return series 238
10 Calibrating Risk Statistics to Market Implied Distributions 241
10.1 Introduction 241
10.2 Market implied risk modelling 241
10.2.1 Refining the granularity-based approach to risk modelling 241
10.2.2 Time horizons 243
10.2.3 Additivity, scalability and coherence 245
10.3 Fully market consistent risk measurement in practice 246
10.3.1 Comparison with current risk management practices 246
10.3.2 The CDO analogy 247
11 Avoiding Undue Pro-cyclicality in Regulatory Frameworks 251
11.1 Introduction 251
11.2 The 2007-09 credit crisis 251
11.3 Underwriting of failures 255
11.4 Possible pro-cyclicality in regulatory frameworks 256
11.5 Re-expressing capital adequacy in a market consistent framework 259
11.6 Discount rates 260
11.7 Pro-cyclicality in Solvency II 261
11.8 Incentive arrangements 263
Contents
11.9 Systemic impacts of pension fund valuations 264
11.10 Sovereign default risk 264
12 Portfolio Construction 267
12.1 Introduction 267
12.2 Risk-return optimisation 267
12.2.1 Introduction 267
12.2.2 The basic mathematics of risk-return optimisation 268
12.2.3 Mean-variance optimisation 268
12.2.4 Constraint-less mean-variance optimisation 270
12.2.5 Alpha-beta separation 270
12.2.6 Multi-period mean-variance optimisation 271
12.3 Other portfolio construction styles 271
12.4 Risk budgeting 272
12.4.1 Introduction 272
12.4.2 Information ratios 273
12.4.3 Sensitivity to the input assumptions 275
12.4.4 Sensitivity to the universe from which ideas are drawn 276
12.5 Reverse optimisation and implied view analysis 276
12.5.1 Implied alphas 276
12.5.2 Consistent implementation of investment ideas across
portfolios 277
12.6 Calibrating portfolio construction techniques to the market 277
12.7 Catering better for non-normality in return distributions 278
12.7.1 Re-normalising historic return distributions 278
12.7.2 Using co-skew, co-kurtosis and other co-moments 279
12.8 Robust optimisation 280
12.8.1 Black-Litterman 280
12.8.2 Re-sampling 281
12.9 Taking due account of other investors risk preferences 281
13 Calibrating Valuations to the Market 283
13.1 Introduction 283
13.2 Price formation and price discovery 283
13.2.1 The price formation process 283
13.2.2 Price discovery 285
13.3 Market consistent asset valuations 287
13.3.1 Introduction 287
13.3.2 Relatively simple assets independent of the firm 287
13.3.3 More complex assets independent of the firm 289
13.3.4 Assets that include risk exposures linked to the firm 291
13.3.5 Further comments 291
13.4 Market consistent liability valuations 296
13.4.1 Introduction 296
13.4.2 Sure promises from infinitely well-capitalised entities 296
13.4.3 Uncertain promises from finitely capitalised entities 298
13.4.4 The solvency put option 299
Contents xi
13.4.5 Bid and offer prices 299
13.4.6 Annuities 300
13.4.7 Unit-linked life insurance 301
13.4.8 With-profits (i.e. participating) business 302
13.4.9 Other non-profit non-linked life insurance 303
13.4.10 Non-life (i.e. property/casualty) insurance 304
13.4.11 Bank deposits 305
13.5 Market consistent embedded values 305
13.6 Solvency add-ons 307
13.6.1 Introduction 307
13.6.2 Current methodologies 307
13.6.3 Full market consistency 308
13.6.4 Correlations 308
13.6.5 Equity market and yield curve movements (market risk) 309
13.6.6 Credit risk 309
13.6.7 Liquidity risk 310
13.6.8 Bid-offer spreads 310
13.6.9 Expense risk 311
13.6.10 Systemic mortality and longevity risks (insurance risk) 311
13.6.11 Other demographic risks 311
13.6.12 Operational risk 311
13.6.13 Non-life (i.e. property/casualty) insurance risk 312
13.7 Defined benefit pension liabilities 313
13.7.1 Introduction 313
13.7.2 Solvency valuations 313
13.7.3 Ongoing valuations 314
13.7.4 Transfer values 315
13.8 Unit pricing 316
14 The Final Word 317
14.1 Conclusions 317
14.2 Market consistent principles 317
Bibliography 325
Index 331
|
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| id | DE-604.BV036630007 |
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| indexdate | 2024-07-09T22:44:34Z |
| institution | BVB |
| isbn | 9780470770887 0470770880 |
| language | English |
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| physical | XXV, 350 S. graph. Darst. 26 cm |
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| spelling | Kemp, Malcolm H. D. Verfasser aut Market consistency model calibration in imperfect markets Malcolm H. D. Kemp Chichester Wiley 2009 XXV, 350 S. graph. Darst. 26 cm txt rdacontent n rdamedia nc rdacarrier Wiley finance series Includes bibliographical references and index Capital market Banks and banking Risk management Bank Kapitalmarkt (DE-588)4029578-3 gnd rswk-swf Risikomanagement (DE-588)4121590-4 gnd rswk-swf Kapitalmarkt (DE-588)4029578-3 s Risikomanagement (DE-588)4121590-4 s b DE-604 HBZ Datenaustausch application/pdf http://bvbr.bib-bvb.de:8991/F?func=service&doc_library=BVB01&local_base=BVB01&doc_number=020549841&sequence=000002&line_number=0001&func_code=DB_RECORDS&service_type=MEDIA Inhaltsverzeichnis |
| spellingShingle | Kemp, Malcolm H. D. Market consistency model calibration in imperfect markets Capital market Banks and banking Risk management Bank Kapitalmarkt (DE-588)4029578-3 gnd Risikomanagement (DE-588)4121590-4 gnd |
| subject_GND | (DE-588)4029578-3 (DE-588)4121590-4 |
| title | Market consistency model calibration in imperfect markets |
| title_auth | Market consistency model calibration in imperfect markets |
| title_exact_search | Market consistency model calibration in imperfect markets |
| title_full | Market consistency model calibration in imperfect markets Malcolm H. D. Kemp |
| title_fullStr | Market consistency model calibration in imperfect markets Malcolm H. D. Kemp |
| title_full_unstemmed | Market consistency model calibration in imperfect markets Malcolm H. D. Kemp |
| title_short | Market consistency |
| title_sort | market consistency model calibration in imperfect markets |
| title_sub | model calibration in imperfect markets |
| topic | Capital market Banks and banking Risk management Bank Kapitalmarkt (DE-588)4029578-3 gnd Risikomanagement (DE-588)4121590-4 gnd |
| topic_facet | Capital market Banks and banking Risk management Bank Kapitalmarkt Risikomanagement |
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