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Stanley Securities September 23, 2010 David Lin Shengbao Luo Casey Wang George Wang Peilin Zhang.

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Presentation on theme: "Stanley Securities September 23, 2010 David Lin Shengbao Luo Casey Wang George Wang Peilin Zhang."— Presentation transcript:

1 Stanley Securities September 23, 2010 David Lin Shengbao Luo Casey Wang George Wang Peilin Zhang

2 Agenda Valuation & Calibration Market Risk Hedging Model Risk P&L

3 Valuation Overview Discount factors Pricing default contingent cash flows with hazard rate process Hazard rate model calibration and parameter selection Spot FX modeling and FX Forward payoff valuation Downgrade threshold determination

4 Pricing Default Contingent Cash Flows PV at time t: And continue backwards, or:

5 Hazard Rate Process Calibration Calculation parameters Calibrated parameters: h 0, θ Fixed parameters: α, v(h t,t) Simulation Parameters Time step Number of paths

6 Hazard Rate Calibration Cont.

7 Downgrade threshold YearA RatedBBB Rated 20000.01000.0218 20010.01380.0277 20020.01830.0265 20030.01070.0195 20040.00520.0105 0.012

8 RCCDS Pricing Results Running Spread (bps) Protection PVUpfront Price Points Upfront Price Stderr CDS (40% Rec)57.25 1,612,1691.65%0.00011% CDS (25% Rec)71.64 2,017,5312.06%0.00012% Full Protection on FX Forward MV 73.97 2,083,2662.13%0.00016% RCCDS47.74 1,344,5631.37%0.00017% RCCDS + knock- out 44.26 1,246,4401.27%0.00017%

9 Market Risk Risk FactorSensitivity ($K) 1 year Stdev 1 day 95% Loss ($K) EUR appreciate by 10%-72511%-83 Credit spread widens by 10 bps-57725 bps-150 Interest rate increases by 10 bpsn/a120 bpsn/a Recovery increases by 10%196n/a

10 Hedging Dynamic delta hedging as part of the credit hybrids portfolio UJB credit risk FX delta IR PV01 Cross partials Risk Factor Hedged Hedge Instrumen t Bid OfferHedge Notional SensitivityDay one hedging cost FX 10%FX Forward 2 bps$5MM$610K FX 10% $1K Credit 10 bps UJB CDS5 bps$125MM$528K Credit 10 bps $31K

11 Model Risk Reduce-form model OU hazard rate process: rate can be negative, and can be different from the real process Model assumptions: alpha, sigma, ratings downgrade hazard rate Coarseness of time steps Knock in knock out between steps

12 How much $ will we make? Fair market value: $1.34MM Offer market value: $1.60MM Day one hedging cost: $32K Day one P&L: $228K

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