Index acceptable portfolios 23, 25–6 asymmetries analysis 342–5 accumulated value 77–83 asymptotic MEWMA control charts advanced measurement approach 251, 253, 254–8 (AMA) 2 atomic simulation 165 calibration 12–16 augmented Dickey–Fuller (ADF) test aggregate desirability of a portfolio 307 29–30 Australia 328 Agrawal, D. 108 autocorrelation 339 Akhavein, J. 109 autoregressive models 48 α-stable distributions 146–50 NPV probability distribution and α-stable intensity-based model autoregressive cash flows 286–7, 148–50 288, 289–93, 297–301 properties of the family 146–7 average run lengths (ARLs) 247, 254, simulation 147–8 255–8 American Depository Receipts (ADRs) average stock risk 108–9 305 Andersen, L. 354 Andersen, T.G. 115, 246 Bachelier, L. 194 Andersson, E. 242 backtesting 200 Andreasen, J. 354 VaR models 214–17 approximations, models as 198 backward-looking models 200 Aragó, V. 304 Balkema, A.A. 7 Aramov, D. 108 bankruptcy, probability of 283–4 arbitrage models 92 Basel Committee on Banking ARCH models 48, 86–7 Supervision 1 conditional volatility 89–91 Basel II framework 1–2, 8 ARCH test 306–7 basic indicator approach (BIA) 2 Artzner, P. 22, 24–5, 27, 28 basic multivariate normal (BMVN) asymmetric covariance 328–9, 348, method 161–8 349–50, 351 accurate estimation of correlation asymmetric dynamic covariance matrix 162–3 (ADM) model 329–51 consistency between valuation of asymmetric volatility 328–9, 348, single contracts and portfolios 349–50, 351 166–7 asymmetric volatility impulse response dealing with non-normality 163–4 function (AVIRF) 311–12, 317–21, estimating model error 164 322, 323 estimating sampling error 167 asymmetrical information 283 estimating VaR 167–8 365 366 INDEX basic multivariate normal (BMVN) Canadian government yield curve method continued 97–102, 103 incorporation of hedging constraints capital asset pricing model (CAPM) 165–6 278–9, 280–4 incorporation of sampling error 162 conditional see conditional CAPM Bayesian model averaging 164 ADC model Bekaert, G. 329 decision rule 282–3 BEKK model 330 capital charge for operational risk asymmetric VaR-BEKK model 1–21 309–11, 312–17, 322 capital investment projects 278–302 Berkowitz, J. 216 Carr, P. 357 Bermudian options 210 Ceci, V. 48 beta central limit theorem (CLT) 285–301 volatility and debt 118–23 and the first-order autoregressive volatility transmission in Europe process 297–301 342–4, 345, 351 and the NPV probability distribution binomial distribution 4 285–97; simulation models and negative 4–5 statistical tests 288–9; simulation Black, F. 109, 110, 117, 194 results 289–93; theoretical results Black–Scholes option pricing model 285–7 109, 198, 201, 208, 353, 356 certainty equivalent approach 282–3 implied volatility 195–7 CEV-ARCH models 90–1 blank sheet syndrome 205 Chambers, J.M. 148 block maxima method 7 Chapelle, A. 8 Blume, L. 48 Chatfield, C. 216 Blume, M. 280 Chen, L. 70 Bock, B. 242 Chen, R.-R. 125 Bodnar, O. 243, 258 chi squared test 5 Bohn, J. 109 Christie, A.A. 329 Bollerslev, T. 54, 115, 246, 266, 311, Christoffersen, P. 214, 215, 216 330, 335 collection threshold 2, 8–16, 17 Bollinger bands 87, 99, 100, 101–2, 103 impact on capital charge for bond portfolios 69–85 operational risk 9–11; empirical bonds analysis 11–16, 17, 18, 19 inflation-linked 172–3; optimal selection 8–9 portfolios 176–82 Collin-Dufresne, P.P. 108, 124 inflation-linked products and comparative Bayesian analysis 221–2, hedging 182–9 223 zero-coupon see zero-coupon bonds conditional CAPM ADC model Booth, G. 305 329–51 Borgonovo, E. 50, 51 asymmetries analysis 342–5 bounds for credit spreads 125–6 model estimates 335–41 Braun, P.A. 329 volatility spillovers 345–8, 349–50 British stock market 331–51 conditional correlations 210 Britten-Jones, M. 258 conditional volatility 86–7, 88–92 burn analysis 160–1 Conover, W. 163 Conrad, J. 328 constant correlation coefficient model CAC40 index 331–51 266, 330 calibration, model 200 Cont, R. 360 call options 74–5, 158 convexity, generalized 74, 76–7 Campbell, J.Y. 87, 108, 111 copulas 163–4 Campbell, S.D. 215 correlated frailty intensity-based Campolongo, F. 49, 59 models 143–6 INDEX 367 correlation breakdowns 226–40 de Haan, L. 7 correlation jumps and volatility De Jong, F. 103 behaviour 228–36 debt, volatility and 118–23 data and descriptive statistics 226–8 debt financing 285 impact on portfolio optimization debt pricing see credit risk valuation 237, 238, 239 decrease in slope of yield curve correlation matrix 161, 162–3 (flattening) 79–81 correlations default events correlations 134, 136, between default events see default 138–9, 150–1 events correlations and default probabilities in empirical study of time-varying intensity-based models 139–41 return correlations and the efficient large time horizons 139, 152–4 set of portfolios 265–77 default probabilities model risk and 210 intensity-based models 137; and costless contracting 283–4 default events correlations Courtadon, G. 210 139–41 covariance Merton-style models 133, 134 asymmetric 328–9, 348, 349–50, 351 default risk 108 conditional 342–7 deflation protection 178–81 covariance structure of asset returns Delbaen, F. 22, 24–5, 27, 28 and optimal portfolio weights Delianedis, G. 108 243–6 dependence levels 132–55 monitoring changes in covariance comparison between dependence matrix see sequential control indicators 139–43 procedures extensions of basic intensity-based Cox model 136–7 model 143–50 Crama, Y. 8 intensity-based models 136–9 Cramer–von Mises test 6 Merton-style models 133–6 crash-phobia 196 derivatives 26, 34, 35, 159 credit risk valuation 107–31 evolution of pricing models 194–5 general model 110–14; basic setting model risk and 191–212 110–12; stochastic volatility and model selection and its impact on Merton’s pricing 112–14 hedging 353–64 simulation study 118–26; credit role of models for 197–9 spread 123–6, 127; volatility and see also under individual types of debt 118–23 derivative stochastic volatility model 114–17 Derman, E. 192, 354 credit spreads 123–6, 127 deterministic (local volatility) models crises 304 354 Crnkovic, C. 216 Di Graziano, G. 357, 358, 360 Crocket, J. 280 Diebold, F.X. 103, 115, 216, 246 Crosier, R.B. 249 differential importance measure 49, cross-section approach to VaR 50–1, 65–6 backtesting 217–24 trading strategies and 58–65 applications 219–24 DIPO 8 CUSUM control charts 248–50 discount bonds price 70–2 projected pursuit CUSUM 249–50, discount rates 286–7, 288, 290–3, 252–3 293–4 vector valued CUSUM 249 diversification-based risk measure 22–46 daily level simulation 165–6 economic motivation 29–30 Danilov, D. 103 implementation 33–7 data verification 208 numerical example 31–3 Day, J. 92 pricing portfolio insurance 37–43 368 INDEX diversification-based risk measure exotic derivatives 209–10 continued expiry value 167 properties of the measure 27–8, extended Kalman filter (EKF) 87, 94, 44–5 95 dollar-denominated risk 26–7 algorithm 96 insurance and 42–3 application to Fong and Vasicek double exponential distribution 288, model 96–7 291–3, 294 simulation of interest-rate term Dow Jones Industrial Average Index structure 99–103 time-varying return correlations and extreme value theory 7–8, 12–16, 217 efficient set of portfolios 269–76 algorithm for finding the threshold trading strategies through sensitivity 8, 12, 18–19 analysis 56–66 Drachman, J. 216 failures analysis 222–4 Drudi, F. 48 falsifiability 281 Dupire, B. 354 Fama, E.F. 108, 280, 282 duration 69–70, 84 Fernández, A. 304 generalized 72–4, 75 Figlewski, S. 192 proposed solution for limitations of financial crises 304 75–83 financial derivatives see derivatives Durbin-Watson statistic 229, 230, 239 financial distress, probability of 283–4 dynamic conditional correlation (DCC) financial services 57, 63, 64 models 266, 268–76 financing of a firm 285 firm preferences 35–7 Ebens, H. 115, 246 first-order autoregressive process Eber, J.M. 22, 24–5, 27, 28 286–7, 288, 289–93, 297–301 Eberlain, E. 109 Fisher equation 171 economic motivation 29–30 Flannery, M.J. 285 efficient market hypothesis 282 flattening of yield curve 79–81 efficient set of portfolios 265–77 Follmer, H. 23, 28 El Karoui, N. 357 Fong, H.G. 87 elasticity 48–9, 51, 53, 65 Fong and Vasicek model 87, 93–4 Elton, E.J. 108 application of extended Kalman filter Embrechts, P. 4, 7 to 96–7; discretization 96–7; energy sector 57, 63, 64, 65 linearization 97 Engle, R.F. 53–4, 86, 266, 268, 330, 342 calibration 98 Eom, J.H. 109, 128 data 97–8 equilibrium models of interest rate simulation of interest rate term term structure 92, 93 structure 99–103 equity 121–2 Fornari, F. 87, 90–1 equity financing 285 forward contracts 26, 34 Eraker, B. 354 forward-looking models 200 Ericsson, J. 127 Frachot, A. 3, 8, 9 Euro area 226–36 frailty models 136–7 Europe, volatility transmission in see also intensity-based models 327–52 French, K.R. 108, 280 European call options 172 French stock market 331–51 debt pricing 113–14, 116–17 frequency distribution 4–5, 17 EWMA control chart Frey, R. 48 comparison of multivariate and frictionless economy 282 simultaneous 254–8 Friedman, M. 280 multivariate 250–1, 254–8, 259 Friend, I. 280 simultaneous 253, 254–8, 259 Frisen, M. 242, 258 exchange traded contracts 158 FTSE100 index 331–51 INDEX 369 futures contracts 26, 34, 35 model risk and 202–3 super-hedging strategies 203 Galluccio, S.