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E-grāmata: Handbook of Fixed-Income Securities

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A comprehensive guide to the current theories and methodologies intrinsic to fixed-income securities

Written by well-known experts from a cross section of academia and finance, Handbook of Fixed-Income Securities features a compilation of the most up-to-date fixed-income securities techniques and methods. The book presents crucial topics of fixed income in an accessible and logical format. Emphasizing empirical research and real-life applications, the book explores a wide range of topics from the risk and return of fixed-income investments, to the impact of monetary policy on interest rates, to the post-crisis new regulatory landscape.

Well organized to cover critical topics in fixed income, Handbook of Fixed-Income Securities is divided into eight main sections that feature:

An introduction to fixed-income markets such as Treasury bonds, inflation-protected securities, money markets, mortgage-backed securities, and the basic analytics that characterize them

Monetary policy and fixed-income markets, which highlight the recent empirical evidence on the central banks influence on interest rates, including the recent quantitative easing experiments

Interest rate risk measurement and management with a special focus on the most recent techniques and methodologies for asset-liability management under regulatory constraints

The predictability of bond returns with a critical discussion of the empirical evidence on time-varying bond risk premia, both in the United States and abroad, and their sources, such as liquidity and volatility

Advanced topics, with a focus on the most recent research on term structure models and econometrics, the dynamics of bond illiquidity, and the puzzling dynamics of stocks and bonds

Derivatives markets, including a detailed discussion of the new regulatory landscape after the financial crisis and an introduction to no-arbitrage derivatives pricing

Further topics on derivatives pricing that cover modern valuation techniques, such as Monte Carlo simulations, volatility surfaces, and no-arbitrage pricing with regulatory constraints

Corporate and sovereign bonds with a detailed discussion of the tools required to analyze default risk, the relevant empirical evidence, and a special focus on the recent sovereign crises

A complete reference for practitioners in the fields of finance, business, applied statistics, econometrics, and engineering, Handbook of Fixed-Income Securities is also a useful supplementary textbook for graduate and MBA-level courses on fixed-income securities, risk management, volatility, bonds, derivatives, and financial markets.

Pietro Veronesi, PhD, is Roman Family Professor of Finance at the University of Chicago Booth School of Business, where he teaches Masters and PhD-level courses in fixed income, risk management, and asset pricing. Published in leading academic journals and honored by numerous awards, his research focuses on stock and bond valuation, return predictability, bubbles and crashes, and the relation between asset prices and government policies.
Notes on Contributors xix
Preface xxv
Part I Fixed Income Markets 1(74)
1 Fixed Income Markets: An Introduction
3(22)
1.1 Introduction
3(4)
1.2 U.S. Treasury Bills, Notes, and Bonds
7(1)
1.3 Interest Rates, Yields, and Discounting
8(1)
1.4 The Term Structure of Interest Rates
9(8)
1.4.1 The Economics of the Nominal Yield Curve
9(4)
1.4.2 The Expectations Hypothesis
13(3)
1.4.3 Forward Rates as Expectation of Future Interest Rates?
16(1)
1.4.4 Interpreting a Steepening of the Yield Curve
17(1)
1.5 Pricing Coupon Notes and Bonds
17(2)
1.5.1 Estimating the Zero-Coupon Discount Function
18(1)
1.5.2 Data and Bond Illiquidity
19(1)
1.6 Inflation-Protected Securities
19(3)
1.7 Floating Rate Notes
22(2)
1.8 Conclusion
24(1)
References
24(1)
2 Money Market Instruments
25(16)
2.1 Overview of the Money Market
25(1)
2.2 U.S. Treasury Bills
26(1)
2.3 Commercial Paper
27(2)
2.3.1 General Facts about Commercial Paper
27(1)
2.3.2 Nonasset-Backed Commercial Paper
27(1)
2.3.3 Asset-Backed Commercial Paper
28(1)
2.4 Discount Window
29(1)
2.5 Eurodollars
29(3)
2.5.1 Eurodollar Futures
31(1)
2.6 Repurchase Agreements
32(3)
2.6.1 Types of Repos and Haircuts
32(1)
2.6.2 Basic Forms of Repo Collateral
33(1)
2.6.3 Repo Rates and Collateral Value Risks
34(1)
2.6.4 The Run on Repo During the Financial Crisis
34(1)
2.7 Interbank Loans
35(5)
2.7.1 Federal Funds
35(2)
2.7.2 LIBOR
37(1)
2.7.3 Overnight Index Swaps and LIBOR-OIS Spreads
38(1)
2.7.4 A Model of LIBOR-OIS Spreads
38(2)
2.8 Conclusion
40(1)
References
40(1)
3 Inflation-Adjusted Bonds and the Inflation Risk Premium
41(12)
3.1 Inflation-Indexed Bonds
41(1)
3.1.1 Mechanics of TIPS
42(1)
3.1.2 Valuing an Inflation-Indexed Bond
42(1)
3.2 Inflation Derivatives
42(1)
3.2.1 Constructing a Synthetic Nominal Treasury Bond with Inflation Swaps
42(1)
3.3 No-Arbitrage Pricing
43(1)
3.3.1 Zero-Coupon Bonds
43(1)
3.4 Inflation Risk Premium
43(2)
3.4.1 Determinants of the Inflation Risk Premium
44(1)
3.5 A Look at the Data
45(5)
3.5.1 Break-Even Rates
45(1)
3.5.2 Inflation Swap Rates
46(3)
3.5.3 Inflation Risk Premium
49(1)
3.6 Conclusion
50(1)
3.7 Appendix
50(1)
3.7.1 Breeden-Lucas-Rubinstein Example
50(1)
3.7.2 Disaster Risk
51(1)
3.8 Data Appendix
51(1)
References
52(1)
4 Mortgage-Related Securities (MRSs)
53(22)
4.1 Purpose of the
Chapter
53(1)
4.2 Introduction to MRSs
54(3)
4.2.1 Mortgage and Securitization
54(1)
4.2.2 The Cash Flows of Mortgage Pools
55(2)
4.3 Valuation Overview
57(5)
4.3.1 OAS, OAD, and Negative Convexity
58(2)
4.3.2 Modeling Prepayment and Default
60(2)
4.4 Analyzing an MRS
62(10)
4.4.1 Modeling Prepayment and Default
62(5)
4.4.2 Freddie Mac's STACR
67(4)
4.4.3 Analyzing the STACR Series 2013-DN1
71(1)
4.5 Summary
72(1)
References
73(2)
Part II Monetary Policy And Fixed Income Markets 75(42)
5 Bond Markets and Monetary Policy
77(16)
5.1 Introduction
77(1)
5.2 High-Frequency Identification of Monetary Policy Shocks
78(6)
5.2.1 Learning About Monetary Policy Surprises
79(2)
5.2.2 The Impact on Treasury Bond Yields
81(1)
5.2.3 The Timing of Expected Fed Interventions
82(2)
5.3 Target Versus Path Shocks
84(6)
5.3.1 The Economics of FOMC Meetings and Bond Yields
86(4)
5.4 Conclusions
90(1)
References
91(2)
6 Bond Markets and Unconventional Monetary Policy
93(24)
6.1 Introduction
93(1)
6.2 Unconventional Policies: The Fed, ECB, and BOE
94(7)
6.2.1 Federal Reserve Operations
94(2)
6.2.2 Bank of England Operations
96(1)
6.2.3 European Central Bank Operations
97(4)
6.3 Unconventional Policies: A Theoretical Framework
101(3)
6.3.1 Portfolio Balance (Duration) Channel
102(1)
6.3.2 Signaling Channel
103(1)
6.3.3 Credit and Capital Constraint Channel
103(1)
6.3.4 Preferred Habitat and Asset Scarcity Channel
104(1)
6.4 Unconventional Policies: The Empirical Evidence
104(11)
6.4.1 The Treasury Bond Market
104(9)
6.4.2 The MBS Market
113(2)
6.4.3 How Persistent is the Effect?
115(1)
6.5 Conclusions
115(1)
References
116(1)
Part III Interest Rate Risk Management 117(52)
7 Interest Rate Risk Management and Asset Liability Management
119(28)
7.1 Introduction
119(1)
7.2 Literature Review
120(1)
7.3 Interest Rate Risk Measures
120(7)
7.3.1 Duration
121(1)
7.3.2 Convexity
122(1)
7.3.3 Key Rate Duration
123(1)
7.3.4 Principal Component Analysis and Factor Duration
123(4)
7.4 Application to Asset Liability Management
127(14)
7.4.1 Nature of Liabilities
127(1)
7.4.2 Cash Flow Matching
128(2)
7.4.3 Classic Immunization and Duration Matching
130(3)
7.4.4 Key Rate Duration Matching
133(4)
7.4.5 Factor Duration Matching
137(4)
7.5 Backtesting ALM Strategies
141(1)
7.6 Liability Hedging and Portfolio Construction
142(2)
7.7 Conclusions
144(1)
7.8 Appendix: The Implementation of Principal Component Analysis
145(1)
References
146(1)
8 Optimal Asset Allocation in Asset Liability Management
147(22)
8.1 Introduction
147(3)
8.2 Yield Smoothing
150(1)
8.3 ALM Problem
151(4)
8.3.1 Return and Yield Dynamics
152(1)
8.3.2 Preferences
153(1)
8.3.3 Constraints
154(1)
8.3.4 Data Description and Estimation
155(1)
8.4 Method
155(1)
8.5 Single-Period Portfolio Choice
156(4)
8.5.1 ALM with a VaR Constraint
156(2)
8.5.2 ALM with AFCs
158(2)
8.6 Dynamic Portfolio Choice
160(4)
8.6.1 Welfare and Portfolio Implications of Yield Smoothing
160(1)
8.6.2 Hedging Demands and Regulatory Constraints
161(3)
8.7 Conclusion
164(1)
8.8 Appendix: Return Model Parameter Estimates
165(1)
8.9 Appendix: Benchmark Without Liabilities
165(1)
References
166(3)
Part IV The Predictability Of Bond Returns 169(70)
9 International Bond Risk Premia
171(20)
9.1 Introduction
171(1)
9.2 Literature Review
172(2)
9.3 Notation and International Bond Market Data
174(1)
9.3.1 Notation
174(1)
9.3.2 International Bond Market Data
174(1)
9.4 Unconditional Risk Premia
174(3)
9.4.1 A Long-Term Perspective
174(2)
9.4.2 More Recent Evidence
176(1)
9.5 Conditional Risk Premia
177(8)
9.5.1 Local Predictors of Returns
178(4)
9.5.2 Global Predictors of Returns
182(3)
9.6 Understanding Bond Risk Premia
185(2)
9.6.1 Links to Economic Growth
185(2)
9.6.2 State Dependency
187(1)
9.7 Conclusion and Outlook
187(2)
References
189(2)
10 Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity
191(19)
10.1 Introduction
191(1)
10.2 Brief Literature Review
192(1)
10.3 Bond Data and Definitions
193(1)
10.3.1 Bond Notation and Definitions
193(1)
10.3.2 Yield Data
194(1)
10.4 Estimating the Liquidity Differential Between Inflation-Indexed and Nominal Bond Yields
194(7)
10.4.1 Estimation Strategy
196(1)
10.4.2 Data on Liquidity and Inflation Expectation Proxies
197(1)
10.4.3 Estimating Differential Liquidity
197(4)
10.5 Bond Excess Return Predictability
201(5)
10.5.1 Economic Significance of Bond Risk Premia
205(1)
10.6 Conclusion
206(2)
References
208(2)
11 U.S. Treasury Market: The High-Frequency Evidence
210(29)
11.1 Introduction
210(1)
11.2 The U.S. Treasury Markets During the Financial Crisis
211(6)
11.2.1 Yields
211(1)
11.2.2 Volatility
212(1)
11.2.3 Off-the-Run/On-the-Run Yield Spread
213(1)
11.2.4 Trading Volume and Price Impact
214(1)
11.2.5 Fails
215(1)
11.2.6 Intraday Evidence on March 18, 2009
215(1)
11.2.7 Summary
216(1)
11.3 The Reaction of Bond Prices and Interest Rates to Macroeconomic News
217(11)
11.3.1 Level Effects
217(1)
11.3.2 The Impact of Monetary Policy
218(1)
11.3.3 Realized-Volatility Patterns
219(1)
11.3.4 Macro News and Option-Implied Volatilities
220(2)
11.3.5 ARCH and GARCH Effects
222(2)
11.3.6 Jumps
224(3)
11.3.7 Summary
227(1)
11.4 Market-Microstructure Effects
228(4)
11.4.1 Microstructure Effects in the Cash Market
228(3)
11.4.2 Joint Microstructure Effects in the Cash Market and Futures Markets
231(1)
11.4.3 Summary
232(1)
11.5 Bond Risk Premia
232(2)
11.5.1 Daily Evidence
232(1)
11.5.2 Intraday Evidence
233(1)
11.5.3 Summary
234(1)
11.6 The Impact of High-Frequency Trading
234(2)
11.6.1 The Effects of HFT on Liquidity, Volatility, and Risk Premia
234(2)
11.6.2 Summary
236(1)
11.7 Conclusions
236(1)
References
236(3)
Part V Advanced Topics On Term Structure Models And Their Estimation 239(88)
12 Structural Affine Models for Yield Curve Modeling
241(24)
12.1 Purpose and Structure of This
Chapter
241(1)
12.2 Structural Models
242(1)
12.3 A Simple Taxonomy
242(1)
12.4 Why do we Need No-Arbitrage Models After All?
243(1)
12.5 Affine Models and the Drivers of The Yield Curve
244(3)
12.5.1 Expectations
244(1)
12.5.2 Term (Risk) Premia
244(2)
12.5.3 Convexity
246(1)
12.6 Introducing No-Arbitrage
247(1)
12.7 Which Variables Should One use?
247(2)
12.8 Risk Premia Implied by Affine Models with Constant Market Price of Risk
249(2)
12.9 Testable Predictions: Constant Market Price of Risk
251(1)
12.10 What Do We Know About Excess Returns?
251(1)
12.11 Understanding the Empirical Results on term Premia
252(2)
12.12 Enriching the First-Generation Affine Models
254(1)
12.13 Latent Variables: The D'Amico, Kim, and Wei Model
254(1)
12.14 From Linear Regressors to Affine Models: the ACM Approach
255(1)
12.15 Affine Models using Principal Components as Factors
256(2)
12.16 The Predictions from the "Modern" Models
258(3)
12.17 Conclusions
261(2)
12.17.1 Models as Enforcers of Parsimony and Builders of Confidence
261(1)
12.17.2 Models as Enforcers of Cross-Sectional Restrictions
262(1)
12.17.3 Models as Revealers of Forward-Looking Informations
262(1)
12.17.4 Models as Enhancers of Understanding
262(1)
References
263(2)
13 The Econometrics of Fixed-Income Markets
265(17)
13.1 Introduction
265(1)
13.2 Different Types of Term Structure Models
266(3)
13.2.1 Factor Models
266(1)
13.2.2 Observable Factors
267(1)
13.2.3 Latent Factors: Filtering versus Indirect Observation
267(1)
13.2.4 Macroeconomic Models
267(1)
13.2.5 Affine Models
268(1)
13.2.6 Yield-Based Models
268(1)
13.2.7 Forward-Based Models
269(1)
13.3 Parametric Estimation Methods
269(3)
13.3.1 GMM
270(1)
13.3.2 Maximum Likelihood
270(1)
13.3.3 QML
271(1)
13.3.4 Efficient Method of Moments
271(1)
13.3.5 Estimation Bias in Mean-Reversion Parameters
272(1)
13.4 Maximum Likelihood Estimation
272(3)
13.4.1 Observed State Variables
272(1)
13.4.2 Latent State Variables
273(2)
13.5 Constructing the Likelihood Function: Expansion of the Transition Density
275(3)
13.5.1 Reducibility
276(1)
13.5.2 The Irreducible Case
277(1)
13.6 Concluding Remarks
278(1)
References
279(3)
14 Recent Advances in Old Fixed-Income Topics: Liquidity, Learning, and the Lower Bound
282(31)
14.1 Introduction
282(1)
14.2 Liquidity
283(8)
14.2.1 Bills, Notes, and Bonds
283(1)
14.2.2 Market Liquidity and Short-Selling Costs
284(2)
14.2.3 Hedging Demand
286(1)
14.2.4 Risky Arbitrage
287(1)
14.2.5 Segmented Markets and Preferred Habitats
287(1)
14.2.6 Funding Risk
288(2)
14.2.7 Implication for Term Structure Models
290(1)
14.3 Learning
291(10)
14.3.1 Yield Survey Forecasts
292(1)
14.3.2 Affine Term Structure Models
293(4)
14.3.3 Spanning Survey Forecasts
297(2)
14.3.4 Adaptive Learning and Survey Forecasts
299(1)
14.3.5 Equilibrium Models of the Term Structure
300(1)
14.4 Lower Bound
301(8)
14.4.1 Square-Root and Autoregressive Gamma Models
301(2)
14.4.2 Black (1995) - Tobin (1958)
303(2)
14.4.3 No-Dominance Term Structure Models
305(1)
14.4.4 Recent Empirical Results
306(3)
14.5 Conclusion
309(1)
14.6 Appendix: Moments of Truncated Bivariate Distribution
310(1)
References
311(2)
15 The Economics of the Comovement of Stocks and Bonds
313(14)
15.1 Introduction
313(1)
15.2 A Brief Literature Survey
313(2)
15.3 The Stock-Bond Covariance and Learning about Fundamentals
315(4)
15.3.1 Investors' Beliefs About Composite Regimes
316(1)
15.3.2 Valuations and the "Fed Model"
316(2)
15.3.3 Explaining the Time Variation in the Stock-Bond Covariance
318(1)
15.4 Beliefs from Surveys and from the Model
319(1)
15.5 Survey and Model Beliefs and the Stock-Bond Covariance
319(3)
15.6 Some International Evidence
322(3)
15.7 Summary
325(1)
References
325(2)
Part VI Derivatives: Markets And Pricing 327(108)
16 Interest Rate Derivatives Products and Recent Market Activity in the New Regulatory Framework
329(60)
16.1 Introduction
329(2)
16.2 Background on the New Derivatives Regulatory Framework
331(4)
16.2.1 Clearing
332(1)
16.2.2 Execution
333(1)
16.2.3 Reporting
333(2)
16.3 Exchange-Traded Derivatives
335(6)
16.3.1 Major Products
335(1)
16.3.2 Execution
336(1)
16.3.3 Clearing
336(3)
16.3.4 Market Activity
339(2)
16.4 Noncleared Swaps
341(13)
16.4.1 Major Products
341(1)
16.4.2 Execution
342(3)
16.4.3 Credit Risk Mitigation
345(6)
16.4.4 Market Activity
351(3)
16.5 Cleared Swaps
354(6)
16.5.1 Major Products
354(1)
16.5.2 Market Activity
355(5)
16.6 Comparative Market Activity Across Execution Venues
360(6)
16.6.1 OTC versus Exchange-Traded Interest Rate Derivatives
360(3)
16.6.2 Bilateral versus SEF Execution of OTC Interest Rate Derivatives
363(3)
16.7 Liquidity Fragmentation in Nondollar Swaps
366(2)
16.8 Prospects for the Future
368(3)
16.8.1 Cleared Swaps and Exchange-Traded Interest Rate Derivatives
369(1)
16.8.2 Swap Futures
370(1)
16.8.3 Noncleared Swaps and End Users
370(1)
16.9 Appendix: The New Regulatory Framework for Interest Rate Derivatives in the United States and European Union
371(14)
16.9.1 Classifications of Market Participants
371(2)
16.9.2 Clearing
373(2)
16.9.3 Execution
375(1)
16.9.4 Reporting
376(1)
16.9.5 Margin Requirements for Noncleared Swaps
377(2)
16.9.6 Capital Requirements for Noncleared Swaps
379(2)
16.9.7 Cross-Border and Extraterritoriality Issues
381(4)
References
385(4)
17 Risk-Neutral Pricing: Trees
389(25)
17.1 Introduction
389(1)
17.2 Binomial Trees
389(5)
17.2.1 One-Step Binomial Trees
389(4)
17.2.2 The Market Price of Risk
393(1)
17.3 Risk-Neutral Pricing on Multistep Trees
394(9)
17.3.1 Calibration of Risk-Neutral Trees to the Yield Curve
395(2)
17.3.2 The Pricing of European Options
397(3)
17.3.3 The Pricing of American Options
400(3)
17.4 From Diffusion Models to Binomial Trees
403(3)
17.4.1 The Hull and White Model
405(1)
17.5 Trinomial Trees
406(7)
17.5.1 Calibration to the Yield Curve
407(3)
17.5.2 Pricing Bermudan Contracts Using the Trinomial Tree
410(2)
17.5.3 Calibration to the Volatility Curve
412(1)
References
413(1)
18 Discounting and Derivative Pricing Before and After the Financial Crisis: An Introduction
414(21)
18.1 Introduction
414(1)
18.2 Forward Rate Agreements (FRAs)
415(7)
18.2.1 Forward Rates
417(1)
18.2.2 Forward Rates after the Crisis
418(2)
18.2.3 A Simple Explanation for the "Arbitrage"
420(2)
18.3 Overnight Index Swaps (OISs)
422(2)
18.3.1 OIS Discount Curve
424(1)
18.4 LIBOR-Based Swaps
424(2)
18.4.1 LIBOR Discount Curve with Single-Curve Pricing
426(1)
18.5 The Crisis and the Double-Curve Pricing of LIBOR-Based Swaps
426(4)
18.5.1 Extracting FRA Rates from Swap Quotes
428(1)
18.5.2 Extracting the Discount Curve from FRA Rates
428(1)
18.5.3 Summing Up
429(1)
18.6 The Pricing of LIBOR-Based Interest Rate Options
430(3)
18.6.1 Black's Option Pricing Formula
430(1)
18.6.2 Caps and Floors before and after the Crisis
431(1)
18.6.3 Swaptions before and after the Crisis
432(1)
18.7 Conclusions
433(1)
References
433(2)
Part VII Advanced Topics In Derivatives Pricing 435(104)
19 Risk-Neutral Pricing: Monte Carlo Simulations
437(32)
19.1 Introduction
437(1)
19.2 Risk-Neutral Pricing
437(9)
19.2.1 Interest Rate Models
440(1)
19.2.2 The Market Price of Risk
441(1)
19.2.3 Valuation under P and under Q
441(1)
19.2.4 Multifactor Models
442(4)
19.3 Risk-Neutral Pricing: Monte Carlo Simulations
446(5)
19.3.1 Discretization of the Vasicek Model
447(1)
19.3.2 Discretization of the Cox-Ingersoll-Ross Model
448(3)
19.3.3 Interest Rate Modeling at the Zero Lower Bound
451(1)
19.4 Valuation by Monte Carlo Simulation
451(10)
19.4.1 Valuation of Securities with Payoff at Fixed Date
452(3)
19.4.2 MC Valuation of Callable Bonds
455(1)
19.4.3 MC Valuation of Securities with American or Bermudan Exercise Style
456(5)
19.5 Monte Carlo Simulations in Multifactor Models
461(6)
19.5.1 Discretization Procedure of the Affine Factor Models
462(1)
19.5.2 MC Simulations for Callable Securities in Multifactor Models
462(5)
19.6 Conclusion
467(1)
References
467(2)
20 Interest Rate Derivatives and Volatility
469(45)
20.1 Introduction
469(1)
20.2 Markets and the Institutional Context
469(4)
20.2.1 Market Size
469(2)
20.2.2 OTC IRD Trading and Volatility
471(1)
20.2.3 Exchange-Listed IRD Trading and Volatility
472(1)
20.2.4 Recent Developments in the IRD Market
473(1)
20.3 Dissecting the Instruments
473(6)
20.3.1 Government Bonds
474(2)
20.3.2 Time Deposits
476(1)
20.3.3 Forwards Rate Agreements and Interest Rate Swaps
476(2)
20.3.4 Caps, Floors, and Swaptions
478(1)
20.4 Evaluation Paradigms
479(8)
20.4.1 Models of the Short-term Rate
479(2)
20.4.2 No-Arbitrage Models
481(4)
20.4.3 Volatility
485(2)
20.5 Pricing and Trading Volatility
487(20)
20.5.1 Standard Volatility Trading Practice
488(1)
20.5.2 An Introduction to Interest Rate Variance Swaps
489(8)
20.5.3 Pricing Volatility in Three Markets
497(5)
20.5.4 Current Forward-Looking Indexes of IRV
502(3)
20.5.5 Products on IRV Indexes
505(2)
20.6 Conclusions
507(1)
20.7 Appendix
508(4)
References
512(2)
21 Nonlinear Valuation under Margining and Funding Costs with Residual Credit Risk: A Unified Approach
514(25)
21.1 Introduction
514(2)
21.2 Collateralized Credit and Funding Valuation Adjustments
516(6)
21.2.1 Trading under Collateralization and Closeout Netting
517(3)
21.2.2 Trading under Funding Risk
520(2)
21.3 General Pricing Equation Under Credit, Collateral, and Funding
522(5)
21.3.1 Discrete-Time Solution
523(1)
21.3.2 Continuous-Time Solution
524(3)
21.4 Numerical Results: Extending the Black-Scholes Analysis
527(8)
21.4.1 Monte Carlo Algorithm
527(2)
21.4.2 Market, Credit, and Funding Risk Specification
529(1)
21.4.3 Preliminary Analysis without Credit Risk and with Symmetric Funding Rates
529(2)
21.4.4 Full Analysis with Credit Risk, Collateral, and Funding Costs
531(2)
21.4.5 Nonlinearity Valuation Adjustment
533(2)
21.5 Extensions
535(1)
21.6 Conclusions: Bilateral Prices or Nonlinear Values?
536(1)
References
537(2)
Part VIII Corporate And Sovereign Bonds 539(48)
22 Corporate Bonds
541(20)
22.1 Introduction
541(1)
22.2 Market and Data
542(2)
22.2.1 Data on Bond Characteristics
542(1)
22.2.2 Data on Market Prices
542(1)
22.2.3 Understanding Market Data from TRACE
543(1)
22.3 A Very Simple Model
544(2)
22.3.1 The Credit Spread Arising from Expected Loss
545(1)
22.3.2 Adding a Risk Premium
545(1)
22.4 Structural Models
546(4)
22.4.1 Merton's Model with Beta
546(3)
22.4.2 Bankruptcy Costs
549(1)
22.4.3 Early Default
550(1)
22.5 Reduced-form Models
550(4)
22.5.1 A Useful Approximation
552(1)
22.5.2 Closed-Form Solutions
553(1)
22.6 Risk Premia in Intensity Models
554(2)
22.7 Dealing with Portfolios
556(1)
22.8 Illiquidity as a Source of Spreads
557(1)
22.9 Some Additional Readings
558(1)
22.10 Conclusion
559(1)
References
559(2)
23 Sovereign Credit Risk
561(26)
23.1 Introduction
561(2)
23.2 Literature Review
563(1)
23.3 Modeling Sovereign Default
564(4)
23.3.1 Risk-Neutral Pricing
564(3)
23.3.2 Pricing Sovereign Credit Default Swaps
567(1)
23.3.3 Pricing in a Lognormal Model
568(1)
23.4 Credit Risk Premia
568(1)
23.5 Estimating Intensity Models
569(1)
23.6 Application to Emerging Markets
570(5)
23.6.1 Credit Markets of Emerging Economies
571(1)
23.6.2 Credit Risk Premia in Emerging Credit Markets
572(3)
23.7 Application to the European Debt Crisis
575(5)
23.7.1 Credit Risk Premia in the Eurozone
578(2)
23.8 Conclusion
580(1)
23.9 Appendix: No Arbitrage Pricing
580(4)
23.9.1 The Risk-Neutral Default Intensity
583(1)
References
584(3)
Index 587
Pietro Veronesi, PhD, is Roman Family Professor of Finance at the University of Chicago Booth School of Business, where he teaches Masters and PhD-level courses in fixed income, risk management, and asset pricing. Published in leading academic journals and honored by numerous awards, his research focuses on stock and bond valuation, return predictability, bubbles and crashes, and the relation between asset prices and government policies.
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