New Frontiers in Practical Risk Management English edition Issue n.6-S pring 2015 Iason ltd. and Energisk.org are the editors of Argo newsletter. Iason is the publisher. No one is al- lowed to reproduce or transmit any part of this document in any form or by any means, electronic or mechanical, including photocopying and recording, for any purpose without the express written permission of Iason ltd. Neither editor is responsible for any consequence directly or indirectly stem- ming from the use of any kind of adoption of the methods, models, and ideas appearing in the con- tributions contained in Argo newsletter, nor they assume any responsibility related to the appropri- ateness and/or truth of numbers, figures, and statements expressed by authors of those contributions. New Frontiers in Practical Risk Management Year 2 - Issue Number 6 - Spring 2015 Published in June 2015 First published in October 2013 Last published issues are available online: www.iasonltd.com www.energisk.org Spring 2015 NEW FRONTIERS IN PRACTICAL RISK MANAGEMENT Editors: Antonio CASTAGNA (Co-founder of Iason ltd and CEO of Iason Italia srl) Andrea RONCORONI (ESSEC Business School, Paris) Executive Editor: Luca OLIVO (Iason ltd) Scientific Editorial Board: Fred Espen BENTH (University of Oslo) Alvaro CARTEA (University College London) Antonio CASTAGNA (Co-founder of Iason ltd and CEO of Iason Italia srl) Mark CUMMINS (Dublin City University Business School) Gianluca FUSAI (Cass Business School, London) Sebastian JAIMUNGAL (University of Toronto) Fabio MERCURIO (Bloomberg LP) Andrea RONCORONI (ESSEC Business School, Paris) Rafal WERON (Wroclaw University of Technology) Iason ltd Registered Address: 6 O’Curry Street Limerick 4 Ireland Italian Address: Piazza 4 Novembre, 6 20124 Milano Italy Contact Information: [email protected] www.iasonltd.com Energisk.org Contact Information: [email protected] www.energisk.org Iason ltd and Energisk.org are registered trademark. Articles submission guidelines Argo welcomes the submission of articles on topical subjects related to the risk management. The two core sections are Banking and Finance and Energy and Commodity Finance. Within these two macro areas, articles can be indicatively, but not exhaustively, related to models and methodologies for market, credit, liquidity risk management, valuation of derivatives, asset management, trading strategies, statistical analysis of market data and technology in the financial industry. All articles should contain references to previous literature. The primary criteria for publishing a paper are its quality and importance to the field of finance, without undue regard to its technical difficulty. Argo is a single blind refereed magazine: articles are sent with author details to the Scientific Committee for peer review. The first editorial decision is rendered at the latest within 60 days after receipt of the submission. The author(s) may be requested to revise the article. The editors decide to reject or accept the submitted article. Submissions should be sent to the technical team ([email protected]). LaTex or Word are the preferred format, but PDFs are accepted if submitted with LaTeX code or a Word file of the text. There is no maximum limit, but recommended length is about 4,000 words. If needed, for editing considerations, the technical team may ask the author(s) to cut the article. ADVERTISING FEATURE chasing the future in Finance Iason ltd provides solutions that enable managers, risk-control officers and front office people to understand and value their portfolios. All solutions are built on the principles of soundness, accuracy and clearness. PRICING RISK MEASUREMENT Modern Derivatives Pricing Credit Risk Sound models to value derivative instruments Innovative approach to Credit VaR (CreVar) according with the best and newest market modeling and computation. practice (CVA, DVA and liquidity). Market Risk Innovative and sophisticated solutions for Complex Products market risk measure and management. Sophisticated analytical models, supported by research, in order to effectively and efficiently Counterparty Risk evaluate all kind of exotic structures, Pioneers in the development of CCR and CVA accounting for all the relevant risk factors. measurement models and applications with devoted internal teams in many major banks. 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Follow us on: @Iason_ltd company web page iason iason.network 3 NEW FRONTIERS IN PRACTICAL RISK MANAGEMENT Table of Contents Editorial pag. 05 Antonio Castagna, Andrea Roncoroni and Luca Olivo introduce the new topics of this n. 6 Argo edition. banking & finance Pricing and Risk Management with High-Dimensional Quasi Monte Carlo and Global Sensitivity Analysis pag. 07 Marco Bianchetti, Sergei Kucherenko and Stefano Scoleri Efficient Computation of the Counterparty Credit Risk Exposure pag. 39 Michele Bonollo, Luca Di Persio, Immacolata Oliva and Andrea Semmoloni energy & commodity finance Off-shore Wind Investment under Uncertainty: Optimal Timing, Size and Leverage pag. 57 James Savage, Mark Cummins and Jean Charpin Structural Positions in Oil Futures Contracts pag. 67 Hilary Till Front Cover: Roberto Marcello Baldessari Paesaggio Dinamico, 1915. EDITORIAL Dear Readers, The Spring 2015 issue of Argo magazine will introduce you to really interesting topics in the fields of risk management and energy finance. Before deepening in the content of the newslet- ter, we would like to thank all the academics, professors, market practitioners and contributors that have submitted their papers and research to Argo until now: your job has been fully appreciated. This time the Banking & Finance section presents two effec- tive solutions to overcome the drawbacks of MonteCarlo (MC) approach in financial risk calculation. The first solution is pro- vided by Marco Bianchetti, Sergei Kucherenko and Stefano Sco- leri that will review and apply the high-dimensional Quasi Monte- Carlo (QMC) approach and the Global Sensitivity Analysis (GSA) to price and manage market risk (in terms of greeks) of in- creasingly complex derivative instruments. The second contribu- tion deals with a Quantization approach in order to better evalu- ate counterparty risk: Michele Bonollo, Luca Di Persio, Immaco- lata Oliva and Andrea Semmoloni will show how this approach improves CCR calculation with respect to the current MC one. Shifting the focus to the Energy and Commodity Finance segment of this issue, James Savage, Mark Cummins, and Jean Charpin introduce us with a new real option valuation model which pro- vided the user with a simultaneously optimized assessment with respect to timing, size, and leverage for offshore wind invest- ment under uncertainty. A further contribution features an ar- ticle by Hilary Till, who develops an insightful analysis of in- dicators for taking long-term positions in oil futures contracts. We conclude as usual by encouraging the submission of contributions for the next issues of Argo in order to im- prove each time this newsletter. Detailed information about the process is indicated at the beginning. New and challeng- ing articles are upcoming with the next releases indeed. Enjoy your reading! Antonio Castagna Andrea Roncoroni Luca Olivo Spring 2015 5 NEW FRONTIERS IN PRACTICAL RISK MANAGEMENT AAAA Banking & Finance Market Risk Management Counterparty Risk Manage- ment 6 Pricing and Risk Management with High-Dimensional Quasi Monte Carlo and Global Sensitivity Analysis The authors review and apply Quasi credit, funding, capital valuation adjustments (CVA, Monte Carlo (QMC) and Global Sensi- FVA, KVA, generically called XVAs) and on the risk tivity Analysis (GSA) techniques to pric- management side, for risk measures and capital ing and risk management (greeks) of rep- allocation. Furthermore, they are typically required for regulatory risk internal models and validated by resentative financial instruments of in- regulators. The daily production of prices and risk creasing complexity. Comparing QMC measures for large portfolios with multiple counter- vs standard MC results they find out parties is a computationally intensive task, which that the formers outperform the latters requires a complex framework and an industrial in most cases, including the highest- approach. It is a typical high budget, high effort dimensional simulations and greeks cal- project in banks. culations, showing faster and more sta- In the past decades, much effort was devoted 2 ble convergence to exact or almost ex- to the application of Monte Carlo techniques to derivatives pricing [4, 5, 12, 11]. The main reason is act results. Using GSA, they are that complex financial instruments usually cannot able to fully explain these findings in be priced through analytical formulas, and the com- terms of reduced effective dimension putation of high-dimensional integrals is required. of QMC simulation, allowed in most Monte Carlo simulation is, then, a common way to cases by Brownian bridge discretization.1 tackle such problems, since it reduces integration to function evaluations at many random points and to averaging on such values.