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Author: Ioulia D. Ioffe Publisher: ISBN: Category : Languages : en Pages : 48
Book Description
Knowledge of the term structure of interest rates is undeniably important. It enables the price of a stream of cash flows to be determined and is a key element for pricing certain types of derivative instruments including swaps and forward contracts. It is useful in the formation of economic policy. It is used to calibrate the parameters of the stochastic process assumed to govern the evolution of interest rates. Notwithstanding its importance, estimating the term structure of interest rates remains fraught with difficulty.It is usual to produce an estimate of the term structure that is known to result in arbitrage opportunities. This paper suggests a new way which results in a no-arbitrage estimate of the term structure. The origins of our method lie with the implied valuation philosophy that has its roots in the derivative market and has gained popularity there. We show how the spirit of that philosophy can be applied to the estimation of the term structure.The goal in this paper is to uncover the discount function implicit in the prices and cash flows of bonds, and to infer the implicit selection criterion employed. It is common practice to use only straight bonds to estimate the term structure and to throw out of the sample the bonds with embedded options, resulting in the loss of information and an estimate that is quite likely inaccurate. We will show that discarding this sort of information when estimating the term structure creates the illusion of a puzzle -- the illusion of arbitrage opportunities. This puzzle is apparently negatively valued options implicit in the government bonds of three countries. The approach used for term structure estimation in this paper allows the researcher to harness the information contained in government bonds with embedded options and results in an arbitrage-free estimate of the term structure.
Author: Ioulia D. Ioffe Publisher: ISBN: Category : Languages : en Pages : 48
Book Description
Knowledge of the term structure of interest rates is undeniably important. It enables the price of a stream of cash flows to be determined and is a key element for pricing certain types of derivative instruments including swaps and forward contracts. It is useful in the formation of economic policy. It is used to calibrate the parameters of the stochastic process assumed to govern the evolution of interest rates. Notwithstanding its importance, estimating the term structure of interest rates remains fraught with difficulty.It is usual to produce an estimate of the term structure that is known to result in arbitrage opportunities. This paper suggests a new way which results in a no-arbitrage estimate of the term structure. The origins of our method lie with the implied valuation philosophy that has its roots in the derivative market and has gained popularity there. We show how the spirit of that philosophy can be applied to the estimation of the term structure.The goal in this paper is to uncover the discount function implicit in the prices and cash flows of bonds, and to infer the implicit selection criterion employed. It is common practice to use only straight bonds to estimate the term structure and to throw out of the sample the bonds with embedded options, resulting in the loss of information and an estimate that is quite likely inaccurate. We will show that discarding this sort of information when estimating the term structure creates the illusion of a puzzle -- the illusion of arbitrage opportunities. This puzzle is apparently negatively valued options implicit in the government bonds of three countries. The approach used for term structure estimation in this paper allows the researcher to harness the information contained in government bonds with embedded options and results in an arbitrage-free estimate of the term structure.
Author: Pierre Collin-Dufresne Publisher: ISBN: Category : Languages : en Pages : 62
Book Description
We propose a canonical representation for affine term structure models where the state vector is comprised of the first few Taylor-series components of the yield curve and their quadratic (co-)variations. With this representation: (i) the state variables have simple physical interpretations such as level, slope and curvature, (ii) their dynamics remain affine and tractable, (iii) the model is by construction 'maximal' (i.e., it is the most general model that is econometrically identifiable), and (iv) model-insensitive estimates of the state vector process implied from the term structure are readily available. (Furthermore, this representation may be useful for identifying the state variables in a squared-Gaussian framework where typically there is no one-to-one mapping between observable yields and latent state variables). We find that the 'unrestricted' A1(3) model of Dai and Singleton (2000) estimated by 'inverting' the yield curve for the state variables generates volatility estimates that are negatively correlated with the time series of volatility estimated using a standard GARCH approach. This occurs because the 'unrestricted' A1(3) model imposes the restriction that the volatility state variable is simultaneously a linear combination of yields (i.e., it impacts the cross-section of yields), and the quadratic variation of the spot rate process (i.e., it impacts the time-series of yields). We then investigate the A1(3) model which exhibits 'unspanned stochastic volatility' (USV). This model predicts that the cross section of bond prices is independent of the volatility state variable, and hence breaks the tension between the time-series and cross-sectional features of the term structure inherent in the unrestricted model. We find that explicitly imposing the USV constraint on affine models significantly improves the volatility estimates, while maintaining a good fit cross-sectionally.
Author: Robert R. Bliss Publisher: ISBN: Category : Languages : en Pages :
Book Description
This paper tests and compares five distinct methods for estimating the term structure. The Unsmoothed Fama-Bliss method is an iterative method by which the discount rate function is built up by computing the forward rate necessary to price successively longer maturity bonds. The Smoothed Fama-Bliss "smooths out" these discount rates by fitting an approximating function to the "unsmoothed" rates. The McCulloch method fits a cubic spline to the discount function using an implicit smoothness penalty, while the Fisher-Nychka-Zervos method fits a cubic spline to the forward rate function and makes the smoothness penalty explicit. Lastly, the Extended Nelson-Siegel method, introduced in this paper, fits an exponential approximation of the discount rate function directly to bond prices.The tests demonstrate the dangers of in-sample goodness-of-fit as the sole criterion for judging term structure estimation methods. A series of residual analysis tests are introduced to detect misspecification of the underlying pricing equation relating the term structure to bond prices. These tests establish the presence of unspecified, but nonetheless systematic, omitted factors in the prices of long maturity notes and bonds.Comparisons of the five term structure estimation methods using these parametric and non-parametric tests finds that the Unsmoothed Fama-Bliss does best overall. Differences with some alternatives may not be economically significant given the much larger number of parameters this method estimates. Users seeking a parsimonious representation of the term structure should consider either the Smoothed Fama-Bliss or the Extended Nelson-Siegel methods. One method was found to be unacceptable. The Fisher-Nychka-Zervos cubic spline method performs poorly relative to the alternatives, both in- and out-of-sample. Furthermore, it systematically misprices short maturity issues and suffers from instability in the estimated term structure.
Author: Wolfgang Lemke Publisher: Springer Science & Business Media ISBN: 3540283447 Category : Business & Economics Languages : en Pages : 224
Book Description
This book has been prepared during my work as a research assistant at the Institute for Statistics and Econometrics of the Economics Department at the University of Bielefeld, Germany. It was accepted as a Ph.D. thesis titled "Term Structure Modeling and Estimation in a State Space Framework" at the Department of Economics of the University of Bielefeld in November 2004. It is a pleasure for me to thank all those people who have been helpful in one way or another during the completion of this work. First of all, I would like to express my gratitude to my advisor Professor Joachim Frohn, not only for his guidance and advice throughout the com pletion of my thesis but also for letting me have four very enjoyable years teaching and researching at the Institute for Statistics and Econometrics. I am also grateful to my second advisor Professor Willi Semmler. The project I worked on in one of his seminars in 1999 can really be seen as a starting point for my research on state space models. I thank Professor Thomas Braun for joining the committee for my oral examination.
Author: Michel Crouhy Publisher: World Scientific ISBN: 9814759341 Category : Business & Economics Languages : en Pages : 2039
Book Description
Black and Scholes (1973) and Merton (1973, 1974) (hereafter referred to as BSM) introduced the contingent claim approach (CCA) to the valuation of corporate debt and equity. The BSM modeling framework is also named the 'structural' approach to risky debt valuation. The CCA considers all stakeholders of the corporation as holding contingent claims on the assets of the corporation. Each claim holder has different priorities, maturities and conditions for payouts. It is based on the principle that all the assets belong to all the liability holders.The BSM modeling framework gives the basic fundamental version of the structural model where default is assumed to occur when the net asset value of the firm at the maturity of the pure-discount debt becomes negative, i.e., market value of the assets of the firm falls below the face value of the firm's liabilities. In a regime of limited liability, the shareholders of the firm have the option to default on the firm's debt. Equity can be viewed as a European call option on the firm's assets with a strike price equal to the face value of the firm's debt. Actually, CCA can be used to value all the components of the firm's liabilities, equity, warrants, debt, contingent convertible debt, guarantees, etc.In the four volumes we present the major academic research on CCA in corporate finance starting from 1973, with seminal papers of Black and Scholes (1973) and Merton (1973, 1974). Volume I covers the foundation of CCA and contributions on equity valuation. Volume II focuses on corporate debt valuation and the capital structure of the firm. Volume III presents empirical evidence on the valuation of debt instruments as well as applications of the CCA to various financial arrangements. The papers in Volume IV show how to apply the CCA to analyze sovereign credit risk, contingent convertible bonds (CoCos), deposit insurance and loan guarantees. Volume 1: Foundations of CCA and Equity ValuationVolume 1 presents the seminal papers of Black and Scholes (1973) and Merton (1973, 1974). This volume also includes papers that specifically price equity as a call option on the corporation. It introduces warrants, convertible bonds and taxation as contingent claims on the corporation. It highlights the strong relationship between the CCA and the Modigliani-Miller (M&M) Theorems, and the relation to the Capital Assets Pricing Model (CAPM). Volume 2: Corporate Debt Valuation with CCAVolume 2 concentrates on corporate bond valuation by introducing various types of bonds with different covenants as well as introducing various conditions that trigger default. While empirical evidence indicates that the simple Merton's model underestimates the credit spreads, additional risk factors like jumps can be used to resolve it. Volume 3: Empirical Testing and Applications of CCAVolume 3 includes papers that look at issues in corporate finance that can be explained with the CCA approach. These issues include the effect of dividend policy on the valuation of debt and equity, the pricing of employee stock options and many other issues of corporate governance. Volume 4: Contingent Claims Approach for Banks and Sovereign DebtVolume 4 focuses on the application of the contingent claim approach to banks and other financial intermediaries. Regulation of the banking industry led to the creation of new financial securities (e.g., CoCos) and new types of stakeholders (e.g., deposit insurers).
Author: Iris Claus Publisher: John Wiley & Sons ISBN: 1119565189 Category : Business & Economics Languages : en Pages : 468
Book Description
The literature surveys presented in this edited volume provide readers with up-to-date reviews on eleven contemporary topics in finance. Topics include unconventional monetary policy, implicit bank guarantees, and financial fraud - all linked to the exceptional event of the Global Financial Crisis Explores how recent studies on inflation risk premia and finance and productivity have benefitted from new empirical methods and the availability of relevant data Demonstrates how angel investing, venture capital, relationship lending and microfinance have benefitted from increased research as they have become more seasoned Investigates crowdfunding and crypto-currencies which have both arisen from recent technological developments
Author: Kin Keung Lai Publisher: Routledge ISBN: 1135006997 Category : Business & Economics Languages : en Pages : 102
Book Description
This book provides different financial models based on options to predict underlying asset price and design the risk hedging strategies. Authors of the book have made theoretical innovation to these models to enable the models to be applicable to real market. The book also introduces risk management and hedging strategies based on different criterions. These strategies provide practical guide for real option trading. This book studies the classical stochastic volatility and deterministic volatility models. For the former, the classical Heston model is integrated with volatility term structure. The correlation of Heston model is considered to be variable. For the latter, the local volatility model is improved from experience of financial practice. The improved local volatility surface is then used for price forecasting. VaR and CVaR are employed as standard criterions for risk management. The options trading strategies are also designed combining different types of options and they have been proven to be profitable in real market. This book is a combination of theory and practice. Users will find the applications of these financial models in real market to be effective and efficient.
Author: Frank J. Fabozzi, CFA Publisher: John Wiley & Sons ISBN: 9780471220947 Category : Business & Economics Languages : en Pages : 536
Book Description
This ultimate guide contains an excellent blend of theory and practice This comprehensive guide covers various aspects of model building for fixed income securities and derivatives. Filled with expert advice, valuable insights, and advanced modeling techniques, Interest Rate, Term Structure, and Valuation Modeling is a book that all institutional investors, portfolio managers, and risk professionals should have. John Wiley & Sons, Inc. is proud to be the publisher of the esteemed Frank J. Fabozzi Series. Comprising nearly 100 titles-which include numerous bestsellers—The Frank J. Fabozzi Series is a key resource for finance professionals and academics, strategists and students, and investors. The series is overseen by its eponymous editor, whose expert instruction and presentation of new ideas have been at the forefront of financial publishing for over twenty years. His successful career has provided him with the knowledge, insight, and advice that has led to this comprehensive series. Frank J. Fabozzi, PhD, CFA, CPA, is Editor of the Journal of Portfolio Management, which is read by thousands of institutional investors, as well as editor or author of over 100 books on finance for the professional and academic markets. Currently, Dr. Fabozzi is an adjunct Professor of Finance at Yale University's School of Management and on the board of directors of the Guardian Life family of funds and the Black Rock complex of funds.
Author: Ioulia D. Ioffe
Author: Ioulia D. Ioffe
Author: Pierre Collin-Dufresne
Author: Robert R. Bliss
Author: Wolfgang Lemke
Author: Michel Crouhy
Author: David Meiselman
Author: 
Author: Iris Claus
Author: Kin Keung Lai
Author: Frank J. Fabozzi, CFA