Malcolm Kemp – Market Consistency. Model Calibration in Imperfect Markets

Description

Achieving market consistency could be difficult, even for probably the most established finance practitioners. In Market Consistency: Model Calibration in Imperfect Markets, main skilled Malcolm Kemp reveals readers how they’ll greatest incorporate market consistency throughout all disciplines. Building on the writer’s expertise as a practitioner, author and speaker on the subject, the e book explores how threat administration and associated disciplines may develop as honest valuation rules turn into extra entrenched in finance and regulatory follow.

This is the one textual content that clearly illustrates the way to calibrate threat, pricing and portfolio building fashions to a market constant stage, rigorously explaining in a logical sequence when and the way market consistency ought to be used, what it means for various monetary disciplines and the way it may be achieved for each liquid and illiquid positions.  It explains why market consistency is intrinsically tough to realize with certainty in some varieties of actions, together with computation of hedging parameters, and gives options to even probably the most advanced issues.

The e book additionally reveals the way to greatest mark-to-market illiquid belongings and liabilities and to include these valuations into solvency and different varieties of monetary evaluation; it signifies the way to outline and establish risk-free rates of interest, even when the creditworthiness of governments is now not undoubted; and it explores when practitioners ought to focus most on market consistency and when their purchasers or employers may need much less want for such an emphasis.

Finally, the e book analyses the intrinsic function of regulation and threat administration inside completely different elements of the monetary companies trade, figuring out how and why market consistency is essential to those matters, and highlights why ideally suited regulatory solvency approaches for long run traders like insurers and pension funds might not be the identical as for different monetary market individuals reminiscent of banks and asset managers.

Table of Contents

Preface.

Acknowledgements.

Abbreviations.

Notation.

1 Introduction.

1.1 Market consistency.

1.2 The primacy of the ‘market.

1.3 Calibrating to the ‘market’.

1.4 Structure of the e book.

1.5 Terminology.

2 When is and when isn’t Market Consistency Appropriate?

2.1 Introduction.

2.2 Drawing classes from the traits of cash itself.

2.3 Regulatory drivers favouring market constant valuations.

2.4 Underlying theoretical points of interest of market constant valuations.

2.5 Reasons why some individuals reject market consistency.

2.6 Market making versus position-taking.

2.7 Contracts that embrace discretionary components.

2.8 Valuation and regulation.

2.9 Marking-to-market versus marking-to-model.

2.10 Rational behaviour?

3 Different Meanings given to ‘Market Consistent Valuations’.

3.1 Introduction.

3.2 The underlying objective of a valuation.

3.3 The significance of the ‘marginal’ commerce.

3.4 Different definitions utilized by completely different requirements setters.

3.5 Interpretations utilized by different commentators.

4 Derivative Pricing Theory.

4.1 Introduction.

4.2 The precept of no arbitrage.

4.3 Lattices, martingales and Îto calculus.

4.4 Calibration of pricing algorithms.

4.5 Jumps, stochastic volatility and market frictions.

4.6 Equity, commodity and foreign money derivatives.

4.7 Interest fee derivatives.

4.8 Credit derivatives.

4.9 Volatility derivatives.

4.10 Hybrid devices.

4.11 Monte Carlo strategies.

4.12 Weighted Monte Carlo and analytical analogues.

4.13 Further feedback on calibration.

5 The Risk-free Rate.

5.1 Introduction.

5.2 What can we imply by ‘risk-free’?

5.3 Choosing between doable meanings of ‘risk-free’.

6 Liquidity Theory.

6.1 Introduction.

6.2 Market expertise.

6.3 Lessons to attract from market expertise.

6.4 General rules.

6.5 Exactly what’s liquidity?

6.6 Liquidity of pooled funds.

6.7 Losing management.

7 Risk Measurement Theory.

7.1 Introduction.

7.2 Instrument-specific threat measures.

7.3 Portfolio threat measures.

7.4 Time series-based threat fashions.

7.5 Inherent information limitations relevant to time series-based threat fashions.

7.6 Credit threat modelling.

7.7 Risk attribution.

7.8 Stress testing.

8 Capital Adequacy.

8.1 Introduction.

8.2 Financial stability.

8.3 Banking.

8.4 Insurance.

8.5 Pension funds.

8.6 Different varieties of capital.

9 Calibrating Risk Statistics to Perceived ‘Real World’ Distributions.

9.1 Introduction.

9.2 Referring to market values.

9.3 Backtesting.

9.4 Fitting noticed distributional types.

9.5 Fat-tailed behaviour in particular person return sequence.

9.6 Fat-tailed behaviour in a number of return sequence.

10 Calibrating Risk Statistics to ‘Market Implied’ Distributions.

10.1 Introduction.

10.2 Market implied threat modelling.

10.3 Fully market constant threat measurement in follow.

11 Avoiding Undue Pro-cyclicality in Regulatory Frameworks.

11.1 Introduction.

11.2 The 2007-09 credit score disaster.

11.3 Underwriting of failures.

11.4 Possible pro-cyclicality in regulatory frameworks.

11.5 Re-expressing capital adequacy in a market constant framework.

11.6 Discount charges.

11.7 Pro-cyclicality in Solvency II.

11.8 Incentive preparations.

11.9 Systemic impacts of pension fund valuations.

11.10 Sovereign default threat.

12 Portfolio Construction.

12.1 Introduction.

12.2 Risk-return optimisation.

12.3 Other portfolio building types.

12.4 Risk budgeting.

12.5 Reverse optimisation and implied view evaluation.

12.6 Calibrating portfolio building strategies to the market.

12.7 Catering higher for non-normality in return distributions.

12.8 Robust optimisation.

12.9 Taking due account different traders’ threat preferences.

13 Calibrating Valuations to the Market.

13.1 Introduction.

13.2 Price formation and worth discovery.

13.3 Market constant asset valuations.

13.4 Market constant legal responsibility valuations.

13.5 Market constant embedded values.

13.6 Solvency add-ons.

13.7 Defined profit pension liabilities.

13.8 Unit pricing.

14 The Final Word.

14.1 Conclusions.

14.2 Market constant rules.

Bibliography.

Index.

 

Author Information

Malcolm Kemp is a well-known actuary and skilled in threat and quantitative finance, with over 25 years’ expertise in the monetary companies trade. From 1996 to 2009 he was Head of Quantitative Research at a number one UK funding administration enterprise and earlier than that was a companion in an actuarial consultancy. He is at the moment Managing Director of Nematrian Limited.