Geoff Chaplin

Credit Derivatives (eBook, PDF)

Trading, Investing, and Risk Management

• Format: PDF

Produktbeschreibung

The credit derivatives industry has come under close scrutiny over the past few years, with the recent financial crisis highlighting the instability of a number of credit structures and throwing the industry into turmoil. What has been made clear by recent events is the necessity for a thorough understanding of credit derivatives by all parties involved in a transaction, especially traders, structurers, quants and investors. Fully revised and updated to take in to account the new products, markets and risk requirements post financial crisis, Credit Derivatives: Trading, Investing and Risk Management, Second Edition, covers the subject from a real world perspective, tackling issues such as liquidity, poor data, and credit spreads, to the latest innovations in portfolio products, hedging and risk management techniques. The book concentrates on practical issues and develops an understanding of the products through applications and detailed analysis of the risks and alternative means of trading. It provides: * a description of the key products, applications, and an analysis of typical trades including basis trading, hedging, and credit structuring; * analysis of the industry standard 'default and recovery' and Copula models including many examples, and a description of the models' shortcomings; * tools and techniques for the management of a portfolio or book of credit risks including appropriate and inappropriate methods of correlation risk management; * a thorough analysis of counterparty risk; * an intuitive understanding of credit correlation in reality and in the Copula model. The book is thoroughly updated to reflect the changes the industry has seen over the past 5 years, notably with an analysis of the lead up and causes of the credit crisis. It contains 50% new material, which includes copula valuation and hedging, portfolio optimisation, portfolio products and correlation risk management, pricing in illiquid environments, chapters on the evolution of credit management systems, the credit meltdown and new chapters on the implementation and testing of credit derivative models and systems. The book is accompanied by a website which contains tools for credit derivatives valuation and risk management, illustrating the models used in the book and also providing a valuation toolkit.

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Produktdetails

• Verlag: John Wiley & Sons
• Seitenzahl: 408
• Erscheinungstermin: 17. Juli 2010
• Englisch
• ISBN-13: 9780470689882
• Artikelnr.: 37298590

Autorenporträt

GEOFF CHAPLIN studied mathematics at Cambridge (MA 1972) and Oxford (MSc 1973, DPhil 1975) and trained as an actuary (FFA 1978) while working in a life insurance company. He moved to the City in 1980 and has worked for major banks (including HSBC, Nomura International, and ABN AMRO). As a partner in Reoch Credit he has consulted to law firms, hedge funds, corporate treasurers, institutional investment funds and risk control departments of major banks in the areas of credit and mortality risk. He has been involved in the credit derivatives market since 1996 and life settlements structures since 2003. Geoff has also maintained strong academic interests - he was a visiting (emeritus) professor at the University of Waterloo, Canada, from 1987 until 1999. He has also published many articles in Risk, the Journal of the Institute and Faculty of Actuaries, and others, speaks regularly at conferences and is the author of Credit Derivatives: Risk Management, Trading and Investing (John Wiley & Sons Ltd, 2005) and co-author of Life Settlements and Longevity Structures: Pricing and Risk Management: Investment and Structured Finance (John Wiley & Sons Ltd, 2009).

Inhaltsangabe

Preface to the First Edition xvii Preface to the Second Edition xix Acknowledgements xxi Disclaimer xxiii Table of Spreadsheet Examples and Software xxvii About the Author xxix Part I Credit Background and Credit Derivatives 1 1 Credit Debt and Other Traditional Credit Instruments 3 1.1 Bonds and Loans; Libor Rates and Swaps; 'REPO' and General Collateral Rates 3 1.1.1 Bonds and Loans 3 1.1.2 BBA Libor and Swaps 4 1.1.3 Collateralised Lending and Repo 4 1.1.4 Repo as a Credit Derivative 6 1.2 Credit Debt Versus 'Risk-Free' Debt 6 1.3 Issue Documents, Seniority and the Recovery Process 6 1.3.1 Issue Documents and Default 6 1.3.2 Claim Amount 7 1.3.3 The Recovery Process and Recovery Amount 8 1.3.4 Sovereign versus Corporate Debt 9 1.4 Valuation, Yield and Spread 10 1.5 Buying Risk 10 1.6 Marking to Market, Marking to Model and Reserves 11 1.7 The 'Credit Crunch' and Correlation 12 1.8 Parties Involved in the Credit Markets and Key Terminology 13 2 Default and Recovery Data; Transition Matrices; Historical Pricing 15 2.1 Recovery: Ultimate and Market-Value-Based Recovery 15 2.1.1 Ultimate Recovery 15 2.1.2 Market Recovery 16 2.1.3 Recovery Rates and Industry Sector 18 2.1.4 Recovery and Default Rates and the Economic Cycle 18 2.1.5 Modelling Recovery Rates 18 2.2 Default Rates: Rating and Other Factors 21 2.3 Transition Matrices 21 2.4 'Measures' and Transition Matrix-Based Pricing 22 2.5 Spread Jumps and Spread Volatility Derived from Transition Matrices 26 2.6 Adjusting Transition Matrices 27 3 Asset Swaps and Asset Swap Spread; z-Spread 29 3.1 'Par-Par' Asset Swap Contracts 29 3.1.1 Contract Description and Hedging 29 3.1.2 Hedging 29 3.1.3 Default of the Reference Name 30 3.2 Asset Swap Spread 30 3.3 Maturity and z-Spread 30 3.4 Callable Asset Swaps; 'Perfect' Asset Swaps 32 3.4.1 Callable Asset Swaps 33 3.4.2 'Perfect' Asset Swaps 33 3.5 A Bond Spread Model 33 4 Liquidity, the Credit Pyramid and Market Data 35 4.1 Bond Liquidity 35 4.2 The Credit Pyramid 35 4.3 Engineered and Survey Data 37 4.3.1 Survey Data 37 4.3.2 Engineered Data 38 4.4 Spread and Rating 39 5 Traditional Counterparty Risk Management 41 5.1 Vetting 41 5.2 Collateralisation and Netting 41 5.3 Additional Counterparty Requirements for Credit Derivative Counterparties 42 5.4 Internal Capital Charge 42 6 Credit Portfolios and Portfolio Risk 43 6.1 VaR and counterpartyVaR 43 6.2 Distribution of Forward Values of a Credit Bond 43 6.3 Correlation and the Multi-Factor Normal (Gaussian) Distribution 45 6.4 Correlation and the Correlation Matrix 46 7 Introduction to Credit Derivatives 49 7.1 Products and Users 49 7.1.1 'Traditional' Credit Instruments 49 7.1.2 'Single Name' Credit Derivatives 49 7.1.3 Credit-Linked Notes 50 7.1.4 Portfolio Credit Derivatives 50 7.2 Market Participants and Market Growth 51 Part II Credit Default Swaps and other Single Name Products 55 8 Credit Default Swaps; Product Description and Simple Applications 57 8.1 CDS Product Definition 57 8.1.1 Contract Description and Example 57 8.1.2 Market CDS Quotes and Premium Payment 58 8.1.3 Related Products 59 8.1.4 CDS on Loans: LCDS 60 8.2 Documentation 60 8.2.1 ISDA Documentation and Insurance Contract Differences 60 8.2.2 Reference Obligations, 'Markit RED' and CreditIDs 63 8.3 Credit Triggers for Credit Derivatives 65 8.3.1 Credit Events 65 8.3.2 Restructuring 66 8.4 CDS Applications and Elementary Strategies 67 8.4.1 Single Names 67 8.4.2 Sector/Portfolio Trades 68 8.4.3 Income Generation 69 8.4.4 Regulatory Capital Reduction 70 8.5 Counterparty Risk: PFE for CDS 71 8.6 CDS Trading Desk 71 8.6.1 Mechanics of Transacting a CDS Deal 71 8.6.2 Trade Monitoring, Credit Events, Unwinds 72 8.6.3 CDS Desk Interactions and Organisation 73 8.7 CDS Contract and Convention Changes 2009 73 8.7.1 Credit Derivatives: Review 73 8.7.2 Overview of Recent Changes 74 8.7.3 Contract Changes 74 8.7.4 Convention Changes 79 9 Valuation and Risk: Basic Concepts and the Default and Recovery Model 81 9.1 The Fundamental Credit Arbitrage - Repo Cost 81 9.2 Default and Recovery Model; Claim Amount 82 9.2.1 Claim Amount 82 9.2.2 Recovery Modelling 83 9.2.3 Hazard (Default) Rate Model 85 9.2.4 Choice of Hazard Rate Function/Interpolation Process 85 9.3 Deterministic Default Rate Model 87 9.3.1 CDS Valuation 88 9.3.2 Accrued Interest and the Delivery Option 90 9.3.3 CDS Under Constant Hazard Rate 91 9.3.4 Up-front Premiums 91 9.3.5 Bond Valuation 91 9.3.6 Bond Price Under a Constant Hazard Rate 92 9.3.7 Limiting Cases of the Bond Price 92 9.3.8 Risky Zero Coupon Bonds 93 9.3.9 CDS and Bond Sensitivities 93 9.4 Stochastic Default Rate Model; Hazard and Pseudo-Hazard Rates 94 9.5 Calibration to Market Data 97 9.5.1 Calibrating to CDSs and to Bonds 97 9.5.2 Implied Hazard Rates 98 9.5.3 Calibrating to Bonds: Multiple Solutions for the Hazard Rate 98 9.5.4 Calibrating to Bonds: Implied Recovery and Hazard Rates 98 9.5.5 Implied Hazard Rate Curve and No-Arbitrage 101 9.5.6 Syndicated Loans 101 9.6 CDS Data/Sources 102 9.6.1 Survey Data 102 9.6.2 Data Engineering 104 9.7 Model Errors and Tests 105 9.7.1 Recovery Assumption 105 9.7.2 Interest and Hazard Rate Correlation 106 9.7.3 Reference Name and Counterparty Hazard Rate Correlation 106 9.7.4 Interpolation Assumptions, and the Pseudo-Hazard Rate versus Stochastic Hazard Rate 108 9.8 CDS Risk Factors; Reserves and Model Risk 108 9.8.1 Captured and Hidden Risks 108 9.8.2 Limits 109 9.8.3 Reserves against Implementation Errors 109 9.8.4 Model Reserves 111 10 CDS Deal Examples 113 10.1 A CDS Hedged Against Another CDS 113 10.1.1 Cross-Currency Default Swap Pricing and Hedging 113 10.1.2 Back-to-Back Trades, Default Event Hedges and Curve Trades 118 10.1.3 Hedging Both Credit Event and Spread Risk Simultaneously 120 10.1.4 Seniority Mismatch 122 10.1.5 Trade Level Hedging and Book Basis Hedging 123 10.2 Introduction to Bond Hedging 124 10.2.1 Default Event Hedging 124 10.2.2 Spread Hedging 125 10.2.3 Convertible Bonds and Equity Risk 125 10.3 Hedge and Credit Event Examples 126 11 CDS/Bond Basis Trading 131 11.1 Bond Versus CDS: Liquidity 131 11.2 Bond Repo Cost 132 11.3 Bond Spread Measurement - z-Spread not Asset Swap Spread 133 11.4 Bond Price Impact 133 11.5 Embedded Options in Bonds and Loans 134 11.6 Delivery Option in CDSs 135 11.7 Payoff of Par 136 11.8 Trigger Event Differences 136 11.9 Embedded Repo Option 137 11.10 Putting it All Together 138 12 Forward CDS; Back-to-Back CDS, Mark to Market and CDS Unwind 139 12.1 Forward CDS 139 12.2 Mark-to-Market and Back-to-Back CDS 140 12.3 Unwind Calculation; Off-Market Trade Valuation and Hedging 141 12.4 'Double-Trigger CDS' 142 13 Credit-Linked Notes 145 13.1 CLN Set-Up; Counterparty or Collateral Risk 145 13.2 Embedded Swaps and Options 147 13.3 Costs 148 13.4 Applications 148 13.5 CLN Pricing 149 13.5.1 Basic Pricing 149 13.5.2 CLN Pricing Model 149 13.6 Capital Guaranteed Note 150 14 Digital or 'Fixed Recovery' CDS 155 14.1 Product Description 155 14.2 Pricing, Hedging, Valuation and Risk Calculations 155 14.2.1 Simple Pricing 155 14.2.2 Recovery Assumptions 156 14.2.3 Valuation and Hedging 156 14.3 Trigger Event Differences 157 15 Spread Options, Callable/Puttable Bonds, Callable Asset Swaps, Callable Default Swaps 159 15.1 Product Definitions 159 15.1.1 Vanilla Spread Options and Variations 159 15.1.2 Related Embedded Products 160 15.1.3 Bond Price Options 161 15.1.4 Applications 162 15.2 Model Alternatives and a Stochastic Default Rate Model for Spread Option Pricing 162 15.2.1 Model Approaches 162 15.2.2 Hazard Rate Tree 163 15.2.3 Callable High Yield Bonds 164 15.3 Sensitivities and Hedging 164 16 Total Return Swaps 167 16.1 Product Definition and Examples 167 16.2 Applications 167 16.3 Hedging and Valuation 168 16.3.1 Pricing and Hedging 168 16.3.2 Valuation 169 17 Single Name Book Management 171 17.1 Risk Aggregation 171 17.2 CreditVaR for CDSs 173 18 CDS and Simulation 175 18.1 The Poisson Model and Default Times 175 18.2 Valuation by Monte Carlo Simulation 175 18.3 Sensitivity 178 Part III Portfolio Products 181 19 Portfolio Product Types 183 19.1 Nth-to-Default Baskets 184 19.1.1 First-to-Default Product Definition and Example 184 19.1.2 Documentation and Takeovers 185 19.1.3 Second-(and Higher)-to-Default 187 19.1.4 Applications 187 19.2 'Synthetic' CDOs 188 19.2.1 Standard Indices: Markit iTraxx and Markit cdx 188 19.2.2 Index Options and Modelling Spread 192 19.2.3 CDO Structures on Standard Indices 194 19.2.4 Bespoke Synthetic CDOs 195 19.2.5 Managed Synthetic CDOs: Compliance Tests (OC and IC Tests; WARF; Diversity Score) and Substitutions 200 19.2.6 CDO Squared 203 19.2.7 Funded (CLN) and Unfunded (CDS) Tranches 205 19.2.8 Relationship to nth-to-Default 206 19.2.9 Applications 207 19.2.10 Portfolio Optimisation 208 19.3 Cashflow CDOs 210 19.3.1 Reference Pools 211 19.3.2 Income and Capital Waterfalls: Reserve Accounts 211 19.3.3 Funding and SPVs 213 19.3.4 Balance Sheet CDOs 215 19.3.5 Diversification and Risk Reduction Trades; Credit Bank 218 19.4 Credit Securitisations 220 19.5 Rating 222 19.6 Alternative Levered Credit Portfolio Products 222 19.6.1 Cppi 223 19.6.2 Cpdo 224 19.6.3 Advantages of Market Value CDS Products 226 20 The Normal Copula and Correlation 227 20.1 Default Time Correlation 227 20.1.1 Generating Correlated Default Times 227 20.1.2 Intuitive Understanding of Default Time Correlation 227 20.1.3 Implications of 100% Default Time Correlation 229 20.1.4 N2D, Zero Correlation Case - Exact Pricing and Hedging Formulas 230 20.1.5 N2D, 100% Correlation - Exact Pricing and Hedging Formulas 234 20.1.6 N2D, Recovery Uncertainty 235 20.2 Normal Copula 236 20.2.1 Generating Correlated Default Times under the Normal Copula 237 20.2.2 Correlation Types: Pairwise, Tag, Tranche/Compound and Base Correlation; Factor Correlation 238 20.2.3 Simulation Pricing 239 20.2.4 Variance Reduction Techniques 242 20.2.5 Semi-Closed Form (SCF) Pricing 242 20.3 Correlation 244 20.3.1 Sources of Correlation 244 20.3.2 Constraints: What Makes a Correlation Matrix? 245 20.3.3 Spread Correlation 246 20.3.4 Asset and Equity Correlation 247 20.3.5 Estimation from Historical Data 248 20.3.6 Factor Analysis and Factor Correlation; Tag Correlation 248 20.3.7 Impact on Hedging of Using Historical or Implied Correlations 251 20.3.8 Implied Correlation 251 21 Correlation in Practice 253 21.1 Tranche Correlation 253 21.1.1 Valuation and Key Features 253 21.1.2 Implied Tranche Correlation 256 21.1.3 CDS Curve Adjustment 257 21.1.4 Bid-Offer Impact 257 21.2 Base Correlation 257 21.2.1 Valuation and Key Features 258 21.2.2 Implied Base Correlation 259 21.2.3 Interpolating Base Correlation 260 21.3 Correlated Recoveries 261 21.4 Correlation Regime Change and Other Modelling Approaches 262 21.4.1 Stochastic Correlation: Regime Change Models 262 21.4.2 Spread Factor 263 22 Valuation and Hedging 265 22.1 Valuation Examples 265 22.1.1 F2D Baskets 265 22.1.2 CDO Pricing: Change of Correlation 265 22.1.3 CDO Pricing: Change of Tranching 267 22.1.4 CDO Pricing: Change of Underlying 268 22.1.5 CDO Pricing: Change of Maturity 269 22.1.6 Managed CDO: Substitution and Change of Subordination 269 22.2 Sensitivity Calculation and Hedging 270 22.2.1 Dynamic Hedging: Spread Risk 271 22.2.2 Static Hedging: Default Event Risk 277 22.2.3 Correlation Risk 279 22.2.4 Recovery Risk 280 22.2.5 Convexity Risks 281 22.3 Pricing More Complex Structures 282 22.3.1 CDO Squared 282 22.3.2 Cashflow CDOs 282 22.4 Model Errors and Tests; Alternative Models 284 22.4.1 Captured and Hidden Risks 284 22.4.2 Spread Models 284 22.4.3 Reserves 285 23 Alternative Copulas 289 23.1 Student's t-Distribution 289 23.2 Copulas in General 290 23.3 Archimedean Copulas: Clayton, Gumbel 291 23.4 Clayton at
= 0 and
=
293 23.5 Model Risk 293 24 Correlation Portfolio Management 297 24.1 Static and Dynamic Hedges 297 24.2 Correlation Book Management 298 24.3 CreditVaR and CounterpartyVaR 300 Part IV Default Swaps Including Counterparty Risk 303 25 Single Name CDS 303 25.1 Non-Correlated Counterparty 305 25.2 100% Correlation 306 25.3 Correlated Counterparty: Pricing and Hedging 308 25.4 Choice of Copula 309 25.5 Collateralised Deals and CDS Book Management 309 26 Counterparty CDSs 313 26.1 Pricing 313 26.2 Counterparty CDS (CCDS) Book Management 313 Part V Systems Implementation and Testing 317 27 Mathematical Model and Systems Validation 319 27.1 Testing Procedures 319 27.2 Implementation and Documentation 321 28 System Implementation 323 28.1 Anatomy of a CDO 323 28.1.1 Reference Pool Data 323 28.1.2 Tranche Data 324 28.1.3 Deal Details 324 28.2 Management 325 28.2.1 What is Happening? 325 28.2.2 What Has Happened? 326 28.2.3 What is Likely to Happen and What is the Worst that can Happen? 326 28.2.4 What Opportunities do I Have? 327 28.2.5 Reporting 328 28.2.6 Limits 328 28.3 Valuation 329 28.4 IT Considerations 331 28.4.1 Why are Credit Derivatives Different? 331 28.4.2 Spreadsheet 332 28.4.3 Software Application 332 28.4.4 Buy versus Build 333 Part VI the Credit Crisis 335 29 Cause and Effect: Credit Derivatives and the Crisis of 2007 337 29.1 The Credit Markets Pre-Crisis 337 29.1.1 Bank Motivation 337 29.1.2 Fixed Income Investors 338 29.1.3 Risk Traders versus Risk Absorbers 338 29.1.4 Structured Investment Vehicles 339 29.1.5 Market Liquidity 340 29.2 The Events of MID- 2007 341 29.2.1 Sub-prime Mortgages 341 29.2.2 Investor Impact 342 29.2.3 Bank Impact 343 29.2.4 The Failure of Lehman Brothers and the Bailout of AIG 345 29.3 Issues to be Addressed 346 29.3.1 A Different Rating Agency Process 346 29.3.2 Standardised Nomenclature for Credit Ratings 347 29.3.3 Keeping a Percentage of Originated Risk on Balance Sheet 348 29.3.4 Undrawn Credit Facility Capital Charge 348 29.3.5 The Future of CDOs 349 29.3.6 Mitigating the Negative Impact of Mark-to-Market 349 29.4 Market Clearing Mechanisms 350 29.4.1 Central Credit Counterparty 351 29.4.2 Centralised Clearing and Systemic Risk 351 29.4.3 A Dedicated CCP for CDSs Alone 352 29.4.4 Conclusions 353 Appendix Markit Credit and Loan Indices 355 References 363 Index 365