FINCAD’s Top 10 Blogs of 2016
In 2016, our team here at FINCAD wrote numerous articles aimed at helping you navigate through a challenging market and regulatory landscape. Over the course of the year, we took on many pressing industry topics including the impact of negative interest rates, changes in OTC derivative regulation, and best practices for valuation adjustments – to name a few.
In case you missed any of these, here is a rundown of our top 10 blog posts of 2016. These posts received the most views according to our analytics, and below are summaries of each one, with links to the full text. Enjoy!
1. Valuing Rates Derivatives Using OIS Discounting
Prior to the financial crisis, it was the norm to use LIBOR to determine the value of interest rates derivatives. However, in recent years, banks have paid more attention to OIS rates. Thought leaders, John Hull, PhD, and Alan White, PhD, weigh in on this topic and offer modeling best practices in light of the LIBOR-OIS spread.
2. Valuation Adjustments I
Valuing derivatives was once much simpler than it is today. For example, an interest rate swap could be valued by knowing nothing more than forward LIBOR rates. However, now one must consider OIS rates as well. In this post, Hull and White discuss best practices for credit valuation adjustments (CVA) and debt valuation adjustments (DVA), and why adjoint differentiation (AD) is a powerful tool for calculating Greeks for CVA exposure.
3. Valuation Adjustments 2
Funding valuation adjustments (FVA) are adjustments to the value of a derivatives portfolio for the cost of funding the derivative positions. Despite the fact that FVA is commonly used, there is debate in the industry over whether the concept is financially sound. As a follow up to their prior blog, Valuation Adjustments 1, Hull and White continue the discussion by exploring: the role of FVA in terms of derivatives portfolios, why, they believe, FVA does not make good economic sense, and alternative ways of calculating what the target profit of a deal should be.
4. The LCH-CME Basis and the Need for Multi-Curve Construction
The ever-changing nature of the markets mean that many financial institutions need to constantly reengineer their curve-building technology. Challenges such as the advent of OIS discounting and the LCH-CME basis have left firms with no choice but to spend considerable time and money overhauling their systems. In this post, FINCAD’s Russell Goyder, PhD, explains why firms are spending unnecessarily on updating curve-building systems to adapt to multi-currency CSA’s, negative interest rates and FVA. Russell also explores how future-proof analytics systems allow firms to deal with unlimited curves without recoding.
5. Model and Measures 1
Risk-neutral valuation is without doubt the most important principle in derivative pricing. However, it is important to remember that a risk-neutral world is nothing more than an artificial construct. It does not describe how market variables behave in the real world; the world we actually live in. Hull and White mull over this concept in a recent blog. They discuss why risk neutral valuation works well when interest rates are constant, and what to do when interest rates are stochastic. Insight on how to value complex derivatives that are dependent on several market variables is also provided.
6. Model and Measures 2
In an effort to improve risk management, many leading firms have turned their attention to estimating the behavior of market variables in the real world, rather than the risk-neutral world. For this kind of insight, accurate scenario analysis is needed. In this follow-up to Model and Measures 1, Hull and White discuss why scenario analysis is becoming an increasingly crucial part of risk management, and review top approaches for determining real-world stochastic processes.
7. Managing Swaptions in the Face of Negative Rates
Negative interest rates were originally intended to be only a temporary measure for accelerating the economy. However, we are now more than two years into this experimental monetary policy, which shows no signs of ending. In this post, FINCAD’s Russell Goyder, PhD, gives five reasons why Shifted SABR has emerged as the market standard for modeling swaptions impacted by negative interest rates. Goyder explains how shifted SABR helps market practitioners model the volatility cube and capture the smile dynamics—providing the ability to accurately price and hedge derivatives.
8. Interest Models and Negative Rates
Negative rates create modeling problems, particularly when valuing interest rate derivatives. Here authors Hull and White discuss four different models that can be used for calculating the price of European style interest-rate options such as caps and swap options when rates are low or negative. The writers also explain how to minimize pricing errors resulting from calibrations.
9. 3 Best Practices for Thriving in a Negative Rates Environment
In this post, we reviewed key takeaways from our highly popular webinar: “Negative Rates: Dealing with an Unorthodox Experiment.” During the presentation, FINCAD’s Russell Goyder discussed the origin of negative interest rates, the challenges they are creating and gave best practices for modeling them. Goyder advises that to weather storms like negative rates and others, firms need flexible systems that can help them quickly adapt to the unexpected.
10. Wrong Way Risk in CVA Calculations
Credit value adjustments (CVA) are adjustments to the way a dealer values a portfolio of derivatives with a counterparty to allow for the possibility that the counterparty might default. CVA reduces the value of the portfolio by the amount that is expected to be lost if the counterparty does indeed default. In this post, Hull and White explain the role of right-way and wrong-way risk in calculating CVA, and give modeling best practices.
We have a rich editorial calendar full of exciting topics for 2017. Be sure to check back here regularly to access our updated blog content.