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It goes without saying that there is a significant gap between theoretical quantitative modelling and it’s practical implementation. Black-Scholes does not allow for a volatility smile, no one actually expects local volatilies to be realised and the square route in the Heston volatility process is chosen more for practical implementation considerations, than out of consideration …Read more
The Basel Committee’s final ruling on the treatment of valuation adjustments to liabilities are out, and they reaffirm the derecognition from Tier 1 capital of changes in DVA. “the Committee believes that valuation adjustments to derivative liabilities raise a wide range of prudential concerns, and therefore that conservatism should drive the policy framework in this …Read more
It’s now old news that the Basel Committee are considering scrapping VaR in favour of expected shortfall. Expected shortfall is the expected or average loss given that the loss exceeds the VaR figure. It’s an indication of how big a loss might be, conditioned on the loss being large. The recommendation then for expected shortfall over VaR is …Read more
Revisiting our post on calibration, there’s a fairly stupid example, that at least illustrates the opportunity cost of letting other people analyse your data for you (and callibrating to their prices rather than making your own). Suppose there is a share trading with a return of 10% and a volatility of 0. A common approach …Read more
Or rather, Matt Levine on the Fed on Basel III. An interesting discussion around the rules regarding the mark-to-market of available for sale securities, and the potential (dis)incentives around consumer lending.Read more
Speaking at the Risk Annual Summit, Damiano Brigo warned of the potential introduction of systemic risk by institutions hedging their DVA risk. “If you think about this strategy in 2008, a bank selling protection on Lehman Brothers would have to pay out the settlement in the middle of the crisis, pushing it closer to default. …Read more