Financial Risk Management

Similar documents
Financial Risk Management

P VaR0.01 (X) > 2 VaR 0.01 (X). (10 p) Problem 4

Two hours. To be supplied by the Examinations Office: Mathematical Formula Tables and Statistical Tables THE UNIVERSITY OF MANCHESTER

Bivariate Birnbaum-Saunders Distribution

Operational Risk Aggregation

3.4 Copula approach for modeling default dependency. Two aspects of modeling the default times of several obligors

Comparative Analyses of Expected Shortfall and Value-at-Risk under Market Stress

Operational Risk Aggregation

The University of Chicago, Booth School of Business Business 41202, Spring Quarter 2011, Mr. Ruey S. Tsay. Solutions to Final Exam.

CHOICE THEORY, UTILITY FUNCTIONS AND RISK AVERSION

MATH3075/3975 FINANCIAL MATHEMATICS TUTORIAL PROBLEMS

Modeling of Price. Ximing Wu Texas A&M University

Advanced Tools for Risk Management and Asset Pricing

Much of what appears here comes from ideas presented in the book:

Utility Indifference Pricing and Dynamic Programming Algorithm

Basic notions of probability theory: continuous probability distributions. Piero Baraldi

GRANULARITY ADJUSTMENT FOR DYNAMIC MULTIPLE FACTOR MODELS : SYSTEMATIC VS UNSYSTEMATIC RISKS

Financial Times Series. Lecture 6

Dependence Structure and Extreme Comovements in International Equity and Bond Markets

The University of Chicago, Booth School of Business Business 41202, Spring Quarter 2009, Mr. Ruey S. Tsay. Solutions to Final Exam

Theoretical Problems in Credit Portfolio Modeling 2

ADVANCED OPERATIONAL RISK MODELLING IN BANKS AND INSURANCE COMPANIES

Contagion models with interacting default intensity processes

Definition 9.1 A point estimate is any function T (X 1,..., X n ) of a random sample. We often write an estimator of the parameter θ as ˆθ.

MEASURING PORTFOLIO RISKS USING CONDITIONAL COPULA-AR-GARCH MODEL

Two Hours. Mathematical formula books and statistical tables are to be provided THE UNIVERSITY OF MANCHESTER. 22 January :00 16:00

Information Processing and Limited Liability

Operational Risk Modeling

1. You are given the following information about a stationary AR(2) model:

Modeling Co-movements and Tail Dependency in the International Stock Market via Copulae

**BEGINNING OF EXAMINATION** A random sample of five observations from a population is:

INDIAN INSTITUTE OF SCIENCE STOCHASTIC HYDROLOGY. Lecture -5 Course Instructor : Prof. P. P. MUJUMDAR Department of Civil Engg., IISc.

Risk Measurement in Credit Portfolio Models

Pricing multi-asset financial products with tail dependence using copulas

MAFS Computational Methods for Pricing Structured Products

TEACHING NOTE 98-04: EXCHANGE OPTION PRICING

Implied Systemic Risk Index (work in progress, still at an early stage)

Roy Model of Self-Selection: General Case

Equity correlations implied by index options: estimation and model uncertainty analysis

NEWCASTLE UNIVERSITY SCHOOL OF MATHEMATICS, STATISTICS & PHYSICS SEMESTER 1 SPECIMEN 2 MAS3904. Stochastic Financial Modelling. Time allowed: 2 hours

Chapter 5 Univariate time-series analysis. () Chapter 5 Univariate time-series analysis 1 / 29

The Black-Scholes Model

Effectiveness of CPPI Strategies under Discrete Time Trading

IMPA Commodities Course : Forward Price Models

Is the Potential for International Diversification Disappearing? A Dynamic Copula Approach

Copulas? What copulas? R. Chicheportiche & J.P. Bouchaud, CFM

M5MF6. Advanced Methods in Derivatives Pricing

Approximation Methods in Derivatives Pricing

All Investors are Risk-averse Expected Utility Maximizers. Carole Bernard (UW), Jit Seng Chen (GGY) and Steven Vanduffel (Vrije Universiteit Brussel)

The Black-Scholes Model

Dynamic Portfolio Choice II

Graduate School of Business, University of Chicago Business 41202, Spring Quarter 2007, Mr. Ruey S. Tsay. Solutions to Final Exam

Exam M Fall 2005 PRELIMINARY ANSWER KEY

Structural Models of Credit Risk and Some Applications

Statistical Inference and Methods

PORTFOLIO THEORY. Master in Finance INVESTMENTS. Szabolcs Sebestyén

Financial Econometrics

Copulas, multivariate risk-neutral distributions and implied dependence functions

Pricing Multi-asset Equity Options Driven by a Multidimensional Variance Gamma Process Under Nonlinear Dependence Structures

INTERNATIONAL JOURNAL FOR INNOVATIVE RESEARCH IN MULTIDISCIPLINARY FIELD ISSN Volume - 3, Issue - 2, Feb

MLEMVD: A R Package for Maximum Likelihood Estimation of Multivariate Diffusion Models

The University of Chicago, Booth School of Business Business 41202, Spring Quarter 2012, Mr. Ruey S. Tsay. Solutions to Final Exam

Asymmetric Price Transmission: A Copula Approach

Advanced Topics in Derivative Pricing Models. Topic 4 - Variance products and volatility derivatives

Black-Scholes Option Pricing

Eco504 Spring 2010 C. Sims FINAL EXAM. β t 1 2 φτ2 t subject to (1)

SOLVENCY AND CAPITAL ALLOCATION

The Use of Importance Sampling to Speed Up Stochastic Volatility Simulations

Loss Simulation Model Testing and Enhancement

Estimating Value at Risk of Portfolio: Skewed-EWMA Forecasting via Copula

Report 2 Instructions - SF2980 Risk Management

Chapter 3: Black-Scholes Equation and Its Numerical Evaluation

All Investors are Risk-averse Expected Utility Maximizers

Some developments about a new nonparametric test based on Gini s mean difference

12. Conditional heteroscedastic models (ARCH) MA6622, Ernesto Mordecki, CityU, HK, 2006.

IEOR E4602: Quantitative Risk Management

OPTIMAL PORTFOLIO OF THE GOVERNMENT PENSION INVESTMENT FUND BASED ON THE SYSTEMIC RISK EVALUATED BY A NEW ASYMMETRIC COPULA

Measuring Risk Dependencies in the Solvency II-Framework. Robert Danilo Molinari Tristan Nguyen WHL Graduate School of Business and Economics

Credit Portfolio Risk

IEOR E4703: Monte-Carlo Simulation

Lecture 4. Finite difference and finite element methods

Mixed Logit or Random Parameter Logit Model

Catastrophic crop insurance effectiveness: does it make a difference how yield losses are conditioned?

Large Deviations and Stochastic Volatility with Jumps: Asymptotic Implied Volatility for Affine Models

Asymptotic methods in risk management. Advances in Financial Mathematics

Page 2 Vol. 10 Issue 7 (Ver 1.0) August 2010

Modeling Dependence in the Design of Whole Farm Insurance Contract A Copula-Based Model Approach

Desirable properties for a good model of portfolio credit risk modelling

Comparison results for credit risk portfolios

INSTITUTE AND FACULTY OF ACTUARIES. Curriculum 2019 SPECIMEN SOLUTIONS

2 f. f t S 2. Delta measures the sensitivityof the portfolio value to changes in the price of the underlying

GPD-POT and GEV block maxima

Lecture 2: Stochastic Discount Factor

PORTFOLIO MODELLING USING THE THEORY OF COPULA IN LATVIAN AND AMERICAN EQUITY MARKET

American options and early exercise

An Introduction to Copulas with Applications

Point Estimation. Stat 4570/5570 Material from Devore s book (Ed 8), and Cengage

MODELING AND MANAGEMENT OF NONLINEAR DEPENDENCIES COPULAS IN DYNAMIC FINANCIAL ANALYSIS

An Empirical Analysis of the Dependence Structure of International Equity and Bond Markets Using Regime-switching Copula Model

M.I.T Fall Practice Problems

Transcription:

Financial Risk Management Professor: Thierry Roncalli Evry University Assistant: Enareta Kurtbegu Evry University Tutorial exercices #4 1 Correlation and copulas 1. The bivariate Gaussian copula is given by the following expression: C (u 1, u ) = Φ ( Φ 1 (u 1 ), Φ 1 (u ) ; ρ ) where Φ (x) is the distribution function of univariate standard normal distribution while Φ (x, y; ρ) is the distribution function of the bivariate standard normal distribution with correlation ρ. Let (X 1, X ) be a random Gaussian vector of distribution Φ. Show that the copula of (X 1, X ) is the same with the one of the random vector (Φ (X 1 ), Φ (X )). Deduce an algorithm to simulate the Gaussian copula of parameter ρ.. Let us consider a random vector (R 1, R ) corresponding to the returns of two assets. We assume that R 1 = σ 1 X 1 and R = σ X with (X 1, X ) the random Gaussian vector of distribution Φ and of parameter ρ. Show that the linear correlation of (R 1, R ) is equal to ρ. Let S 1 and S be the normalized asset prices. We have S 1 = e R 1 and S = e R. Show that the linear correlation of (S 1, S ) is equal to 1 if and only if the linear correlation of (R 1, R ) is equal to 1 and if the volatility σ 1 is equal to the volatility σ. Comment this result in the case of Black-Scholes model. 3. Let it be X 1 N (µ 1, σ 1 ) and X N (µ, σ ). We consider that the copula C X1,X is an ordinal sum of copulas C and C + of parameter θ. (a) We assume that µ 1 = µ = 0 and σ 1 = σ = 1. Specify the copula C X1,X such that the linear correlation of X 1 and X is null. Show that there exists a function f such that X 1 = f (X ). Comment this result. (b) Calculate the linear correlation of X 1 and X as a function of the parameters µ 1, µ, σ 1, σ and θ. (c) Propose a method of moments to estimate θ. The exponential distribution 1. Let it be τ E (λ). Show that: Pr {τ > t τ > s} = Pr {τ > t s} with t > s. Interpret this result. Which is its interest in modeling the credit risk?. Let τ 1,..., τ n n be the random variables of distribution E (λ i ). (a) Calculate the distribution of min (τ 1,..., τ n ) et max (τ 1,..., τ n ) in the independent case. (b) Same question if the random variables τ 1,..., τ n are co-monotone. 1

(c) We place ourselves in the independent case. Let us consider τ = min (τ 1,..., τ n ). Show that: Pr {τ = τ i } = λ i n j=1 λ j 3. Let us consider two exponential default times τ 1 and τ of parameter λ 1 and λ. (a) Show that if the dependence function (τ 1, τ ) is C +, then the following relation is true: τ 1 = λ λ 1 τ (b) Show that there exists a function f such that τ 1 = f (τ ) is the dependence function of (τ 1, τ ) is C. (c) We denote ρ the coefficient of linear correlation of (τ 1, τ ). Show that: 1 < ρ 1 (d) In a more general case, show that the correlation coefficient ρ of a random vector (X 1, X ) can not be equal to 1 if the support of the random variables X 1 and X is [0, + ]. 3 Copula functions 1. Let us consider the function: (a) Show that C is a copula 1 for θ [ 1, 1]. C (u 1, u ) = u 1 u (1 + θ (1 u 1 ) (1 u )) (b) Calculate the tail dependence coefficient λ of this copula, the Kendall tau and the Spearman rho as well. (c) Let us consider X 1 N (µ, σ) and X E (λ). We assume that the copula of the random vector (X 1, X ) is the previous function. Propose an algorithm to simulate the random vector (X 1, X ). { (x ) } i (d) Calculate the log-likelihood of the sample 1, x i i=n. i=1. Let S be the bivariate function defined by: with θ [0, 1], x 1 0 et x 0. S (x 1, x ) = exp (a) Show that S is a survival distribution. (b) Define the survival copula associated tos. ( ( x 1 + x θ x )) 1x x 1 + x 3. We recall that an Archimedean copula has the following expression: where φ is a function called generator. C (u 1, u ) = φ 1 (φ (u 1 ) + φ (u )) (a) Under which conditions for φ should we be, in a way C to be a copula? 1 This copula is known with the name of Farlie-Gumbel-Morgenstern (see Nelsen, 1999, page 68).

(b) Are the following copulas C, C and C + Archimedean? If yes, give the corresponding generators. (c) Which is the copula associated to generator φ (u) = ( ln u) θ where θ 1? Show that thos copula is a copula of extreme values. (d) Calculate the conditional distribution C 1 associated to the Archimedean copula. Deduce an algorithm to simulate the Archimedean copula. 4. Let (X 1, X ) be a standard Gaussian vector of correlation ρ. (a) Calculate the distribution of X knowing that X 1 = x 1. (b) Deduce an expression of the copula C associated to (X 1, X ). Calculate the conditional distribution C 1. Deduce an algorithm to simulate the copula C. 5. Which is the property of a copula of extreme values? Show that C and C + are copulas of extreme values, while that is not the case for C. 4 Calculation of the upper/lower bounds of correlation 1. Give the mathematical definitions of the copulas C, C and C +.. Define the Normal bivariate copula C (ρ) of correlation ρ. 3. Which are the probabilistic interpretations of the three copulas defined in question 1? Deduce that C (ρ= 1) = C, C (ρ=0) = C and C (ρ=1) = C +. 4. Let us consider the random vector (τ, LGD) which model the joint law of default τ and the loss given default LGD of a counterpart. We assume that τ E λ and LGD U [0,1]. (a) Show that the dependence of (τ, LGD) is maximal while: LGD +e λτ 1 = 0 (b) Show that the correlation ρ (τ, LGD) verifies the following inequality: (c) Comment these results. ρ (τ, LGD) 3 5 The generalized exponential model 1. We denote F and S the distribution function and the survival function of the random variable τ. Define the function S (t) and deduce the expression of the associated density function f (t).. Give the definition of hazard rate λ (t). Deduce that the exponential model corresponds to a particular case λ (t) = λ. 3. How could we simulate the random variable τ in the case when λ (t) = λ. 4. Let us assume now that: λ 1 if t 3 λ (t) = λ if 3 < t 5 λ 3 if t > 5 Give the expression of the survival distribution S (t). Deduce the expression of the density function f (t). Verify that: f (t) S (t) = constant 3

5. We assume that the interest rate is constant r. We recall that in the case of CDS whose margin is payed in ongoing basis, the spread of CDS is equal to: s = (1 R) T 0 e rt f (t) dt T 0 e rt S (t) dt where S and f are the survival and density functions of default time τ associated to CDS, R is the recovery rate and T is the CDS maturity. Give the triangular equality while τ E λ. 6. Let us consider that τ is the generalized exponential model of question 4. We assume that there exist three market spreads CDS s 1, s and s 3 whose respective maturity are 3 years, 5 years and 7 years. Show that the calibration of the generalized exponential model implies to solve a system of 3 equations and 3 unknowns λ 1, λ and λ 3. Which is the name of this calibration method? 6 Risk contributions We denote L the loss of a portfolio of n credits, and x i the exposure to default of the i-th credit. We have: n L = x e = x i e i with e i the unitary loss of the i-th credit. We denote F the distribution function of L. 1. Let us assume that e = (e 1,..., e n ) N (0, Σ). Calculate the value at risk of confidence level α. i=1. Deduce the marginal value-at-risk of the i-th credit. Define the risk contribution of the i-th credit. 3. Verify that the value at risk is equal to: Interpret this result. VaR x i = E [ e i L = F 1 (α) ] 4. Let us consider the Bâle II model of credit risk.. We have: e i = LGD i D i where D i = 1 {τ i < M i } is the default indicator and the M i is the maturity of the i-th credit. Which are the necessary conditions to be satisfied to obtain the following result: E [ e i L = F 1 (α) ] = E [LGD i ] E [ D i L = F 1 (α) ] 5. We assume that the default occurs before the maturity M i if the latent variable Z i falls below a certain level B i : τ i M i Z i B i We model Z i = ρx + 1 ρε i with Z i, X and ε i three independent standard normal random variables. X is the factor (or the systemic risk) and ε i is the individual. Calculate the conditional probability of default. 6. Show that in the Bâle II model, we have: E [ e i L = F 1 (α) ] = E [LGD i ] E [ D i X = Φ 1 (1 α) ] 7. Deduce the expression of the risk contribution of the i-th credit in the Bâle II model. 4

8. We assume that the portfolio is homogeneous, which means that the credits have the same exposure to default, the same distribution of loss given default and the same default probability. Using the following result: c Φ(a + bx)ϕ(x) dx = Φ (c, a 1 + b ; ) b 1 + b with Φ (x, y; ρ) the distribution function of the bivariate Gaussian distribution of correlation ρ in the domain [, x] [, y], calculate the expected shortfall in the case of Bâle II model. Comment this result. 5