Derivatives:
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Newsletter 4 issues per annum
JOD brings together the most important developments in derivatives theory and practice - for the benefit of the derivatives market professional. It offers sophisticated, results-oriented analysis and provides full treatment of mathematical and statistical information on derivatives products and techniques.
The derivatives market continues to produce some of the most exciting new theories - and products - in the financial community. But in a market that moves at such a rapid pace, how do you stay on top of the latest ideas in derivatives - and how do you put these creative ideas to work?
You’ll find the answer in The Journal of Derivatives, which bridges the gap between academic theory and practical application. With concise, results-oriented analysis on the ever-evolving derivatives market, it probes the most current ideas, developments, and insights on every aspect of the derivatives market, such as:
- Which of the latest bond option pricing models is best?
- How should you price emerging market equity options?
- What are the pros and cons of OTC vs exchange-traded derivative contracts for institutional investors?
Plus, you get the latest techniques on hedging with futures, managing foreign exchange risk, and comparing option pricing models - and current information on evaluating new products, minimizing transaction costs, gauging the effects of regulation, and spotting undervalued opportunities.
The best of our original, market-leading articles for Practitioners - by Practitioners and Academics
The Forward Valuation of Compound Options
Buraschi, Andrea; Dumas, Bernard
vol. 9, No. 1
Reducing Asset Substitution with Warrant and Convertible Debt Issue
Chesney, Marc; Gibson-Asner, Rajna
Vol. 9, No. 1
Beyond the VaR
Longin, Francois
Vol. 8, No. 4
A Markov Chain Model with Stochastic Default Rate for Valuation of Credit Spreads
Kodera, Eiji
Vol. 8, No. 4
Sample Contents:
Volume 9, Number 1
The Forward Valuation of Compound Options
Buraschi, Andrea ; Dumas, Bernard
Fall 2001, Volume 9, Number 1, Pages 8 - 17
The Black-Scholes (BS) model gives the value of a European option when the underlying follows a lognormal distribution with constant volatility. American options, however, require more elaborate procedures, typically coming from what amounts to an approximate solution to a “backward” partial differential equation. Time varying volatility is fairly easily accommodated for European options, so long as it is non-stochastic, but for American options things become more complicated. More complex derivatives, involving compound optionality, for example, can be solved for the simplest cases, but quickly get beyond easy application of current techniques, as complexity grows. In any case, the existing solutions are such that each option requires its own full valuation routine. In this rather remarkable article, Buraschi and Dumas develop a new technique, based on solving a forward equation, that greatly simplifies the entire process. The result is a valuation algorithm that easily handles time varying (non-stochastic) volatility, compound optionality and American exercise. Unlike the “backward” technique, their approach produces an entire valuation surface defined in terms of strike and time to maturity, given current date and stock price. This allows valuation of multiple options on the same underlying with essentially no more computation than pricing a single one.
Recent Advances in Default Swap Valuation
Cheng, Wai-Yan
Fall 2001, Volume 9, Number 1, Pages 18 - 27
Valuing credit risk sensitive instruments is one of the major growth areas in derivatives research. Two main approaches are being thoroughly explored. Merton\'s “structural” approach models the stochastic evolution of total firm value, and default occurs if firm value hits a prespecified lower bound. In the “reduced form” approach, default is a random exogenous event, typically modeled as a Poisson process. The latter camp contains a variety of models that appear to handle the important parameters, jump intensity, the recovery rate in case of default, and riskless interest rates, very differently. In this article, Cheng presents a straightforward synthesis of the reduced form credit risk modeling framework and proves that the major existing models can all be seen as special cases of his general approach. This is extremely useful, both because it leads to a general valuation method, and also simply because it shows that the different existing models should all produce the same results with respect to such things as default probabilities implied by market prices for vulnerable instruments.
Pricing Algorithms for Options with Exotic Path-Dependence
Kwok, Yue Kuen; Lau, Ka Wo
Fall 2001, Volume 9, Number 1, Pages 28 - 38
Path-dependent derivatives present a major challenge to standard valuation algorithms. Closed-form solutions are available for a handful of simple cases like “out” options with continuously monitored barriers, or odd special cases like Asian options based on the geometric average. Basic lattice techniques can work for a somewhat larger subset of instruments, such as discretely monitored barrier options. But as the variety of options traded in the marketplace expands, seemingly without bound, the path-dependency problem quickly becomes formidable. For some important cases, lattice-based solutions have been devised that involve carrying an auxiliary variable through the asset price tree to keep track of the current state of the path at each price node, a technique known as a “Forward Shooting Grid.” In this article, Kwok and Lau demonstrate how to set one up and provide several examples to illustrate its use, pricing Parisian options, both standard and exotic (e.g., a “cumulative Parisian” contract), with complex dependence on the asset price path. The convergence rate in the examples is shown to be proportional to the square root of the number of time steps.
Reducing Asset Substitution with Warrant and Convertible Debt Issue
Chesney, Marc ; Gibson-Asner, Rajna
Fall 2001, Volume 9, Number 1, Pages 39 - 52
The conflict between shareholders and bondholders in a levered firm over the choice of the risk level for firm assets is well-known. The original contingent claims approach to this issue had the firm reaching a critical point at the bond maturity date, similar to what happens at expiration of an option. In that model, equity is shown to be like a call option on the value of the firm. But the reality is that firms are continuously monitored by investors, customers and employees, and may potentially experience financial distress if the value of its assets falls too low at any point in time. In this article, Chesney and Gibson present an alternative contingent claims analysis, in which equity is modeled as a down and out call, with an outstrike equal to the asset level that would precipitate distress. In this revised framework, they are able to study how the use of convertible debt, or debt with attached warrants, in place of straight debt affects the problem of volatility choice, and may perhaps eliminate the conflict of interest entirely.
A Compound Option Model to Value Moral Hazard
Paris, Francesco M.
Fall 2001, Volume 9, Number 1, Pages 53 - 61
Introduction and adoption of new derivative structures can be greatly influenced by government regulation at several levels. The insurance industry in the U.S., for example, faces stringent regulation at the state level, such that use of derivatives for risk management has at times been significantly impeded. Hedging transactions involving derivatives, and some income generation strategies are now generally accepted for insurance companies. But a “new” strategy for insurers, which essentially amounts to a type of arbitrage, has only recently been cleared for use. The transactions are known as “Replication (Synthetic Asset) Transactions” (RSATs). An RSAT amounts to a standard derivatives arbitrage portfolio, in which a position is constructed that mimics the payoff of some other instrument. Claims on the synthetic instrument are then sold in the market, supported by the replicating portfolio. In this article, Driscoll explains the newly adopted regulatory framework that governs how such transactions will be handled in the insurance industry.
Replication (Synthetic Asset) Transactions
Driscoll, Kevin
Fall 2001, Volume 9, Number 1, Pages 62 - 68
Introduction and adoption of new derivative structures can be greatly influenced by government regulation at several levels. The insurance industry in the U.S., for example, faces stringent regulation at the state level, such that use of derivatives for risk management has at times been significantly impeded. Hedging transactions involving derivatives, and some income generation strategies are now generally accepted for insurance companies. But a “new” strategy for insurers, which essentially amounts to a type of arbitrage, has only recently been cleared for use. The transactions are known as “Replication (Synthetic Asset) Transactions” (RSATs). An RSAT amounts to a standard derivatives arbitrage portfolio, in which a position is constructed that mimics the payoff of some other instrument. Claims on the synthetic instrument are then sold in the market, supported by the replicating portfolio. In this article, Driscoll explains the newly adopted regulatory framework that governs how such transactions will be handled in the insurance industry.
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