Modern Derivatives Pricing and Credit Exposure Analysis

Roland Lichters, Roland Stamm, Donal Gallagher

Modern Derivatives Pricing and Credit Exposure Analysis: Theory and Practice of CSA and XVA Pricing, Exposure Simulation and Backtesting

‍The past 10 years have see an incredible change in pricing financial products, driven by the credit crisis which started in 2007 with the near bankruptcy of Bear Sterns, reaching a first climax with the implosion of the US housing market and the banking world's downfall, and then turning into a sovereign debt crisis in Europe. A major change to have affected the landscape has been the increasing complexity in the valuation of derivatives - multi-curve pricing , various value adjustments (XVAs) using Monte Carlo simulation of markets through time , credit risk measurement and capital allocation - all based on increasingly complex mathematical and IT machinery.

Published in November 2015, Modern Derivatives Pricing and Credit Exposure Analysis is a comprehensive, practical guidebook for modern derivatives pricing and credit analysis, written with the practitioner in mind. Theoretically rigorous but focused on market practice, it provides a detailed and consistent toolkit of pricing and risk methods to cope with the increasing complexities of today's derivatives management. The presented risk factor evolution models for six different asset classes allow efficient computation of various value adjustments (XVAs) and risk measures in a competitive and increasingly regulated environment. The text bridges the gap between the risk-neuraland real-world measure for backtesting purposes and explains different methods for speeding up XVA computation in order to allow fast calculations of margin adjustment or XVA greeks.

Written to provide sound theoretical detail with practical implementation, this book provides readers with both an overview and deep dive into valuation and risk methods applied in the industry today.

See the book at the Palgrave Macmillan website.

Part I - Discounting

Discounting Before the Crisis
What Changed With the Crisis
Clearing House Pricing
Global Discounting
CSA Discounting
Fair Value Hedge Accounting

Part II - Credit and Debit Value Adjustment

Fundamentals: Unilateral and Bilateral CVA
Single Trade CVA: Interest Rate Swaps, FX Forwards, Cross Currency Swap Flavours

Part III - Risk factor Evolution

Monte Carlo Framework
Interest Rates: Linear Gauss Markov Model, Stochastic Basis, CSA Discounting Revisited
Foreign Exchange: Multi-Currency LGM, Cross Currency Basis
Inflation: Jarrow-Yildirim and Dodgson-Kainth Models
Equity and Commodity: One and Two-Factor Models
Credit: Gaussian, Extended Cox-Ingersoll-Ross, Black-Karasinski and Peng-Kou Models

Part IV - XVA

Cross Asset Scenario Generation
Netting and Collateral
Early Exercise and American Monte Carlo
CVA Risk and Algorithmic Differentiation
Funding Value Adjustment: FVA Debate, Expectation and Semi-Replication Approach, MVA
Capital and Tax Value Adjustment: KVA by Semi-Replication, TVA

Part V - Credit Risk

Fundamentals, Portfolio Credit Models
Pricing Portfolio Credit Products: Synthetic CDOs, Cashflow Structures
Credit Risk for Derivatives: Real-World Measure, SA-CCR, Internal Model Approach, CVA Capital Charge
Backtesting: Framework, Risk-Factor Backtesting, Portfolio Backtesting

Part VI - Appendix