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"Schoutens, Wim"
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Applied conic finance
\"This is a comprehensive introduction to the brand new theory of conic finance, also referred to as the two-price theory, which determines bid and ask prices in a consistent and fundamentally motivated manner. Whilst theories of one price classically eliminate all risk, the concept of acceptable risks is critical to the foundations of the two-price theory which sees risk elimination as typically unattainable in a modern financial economy. Practical examples and case studies provide the reader with a comprehensive introduction to the fundamentals of the theory, a variety of advanced quantitative models, and numerous real-world applications, including portfolio theory, option positioning, hedging, and trading contexts. This book offers a quantitative and practical approach for readers familiar with the basics of mathematical finance to allow them to boldly go where no quant has gone before\"-- Provided by publisher.
Book
Implied Tail Risk and ESG Ratings
This paper explores whether the high or low ESG rating of a company is related to the level of its implied tail risk, measured on the basis of derivative data by implied skewness and implied kurtosis. Previous research suggests that the ESG rating of a company is indeed connected to some financial risk; however, often, only volatility is used as a risk measure. We examined the relation between ESG ratings and implied volatility, and explore the relation between ESG ratings and financial risk in more depth by looking into higher implied moments accessing financial tail risk. First, we found that higher ESG rated companies have a lower implied volatility connected with them, and exhibit more negative implied skewness and higher implied kurtosis. In other words, we observed a higher negative tail risk for higher ESG rated companies. However, on a midsized company data set, we found that higher ESG rated companies both have lower implied volatility, and exhibit less negative implied skewness and lower implied kurtosis. Hence, negative tail risk is typically lower for high ESG rated companies. Our study further investigated similar effects on individual environmental (E), social (S) and governance (G) scores of the involved companies. Second, we examined whether such a kind of trend exists for different sectors. Our results indicate that the influence of ESG ratings on implied volatility exhibits a similar trend, except for the industrial, information services, and real estate sectors, while for the materials, healthcare, and communication services sectors, the influence of ESG ratings on implied skewness and implied kurtosis is less pronounced. Moreover, the results show that the ESG ratings are correlated with implied moments for companies in consumer discretionary sectors.
Journal Article
Performance of advanced stock price models when it becomes exotic: an empirical study
We calibrate several advanced stock price models to a time series of real market data of European options on the DAX. Via a Monte Carlo simulation, we price barrier down-and-out call options for all models and compare the modeled prices to given real market data of the barrier options. The Bates model reproduces barrier option prices very well. The BNS model overvalues and Lévy models with stochastic time-change and leverage undervalue the exotic options. The Heston model and a local volatility model undervalue the barrier option prices by about 5–6%. A heuristic analysis suggests that the different degree of fluctuation of the random paths of the models are responsible of producing different prices for the barrier options. Higher margins or additional risks like liquidity, calibration or model risk might economically explain why many advanced models undervalue barrier options.
Journal Article
The handbook of hybrid securities : convertible bonds, coco bonds, and bail-in
Introducing a revolutionary new quantitative approach to hybrid securities valuation and risk management
To an equity trader they are shares. For the trader at the fixed income desk, they are bonds (after all, they pay coupons, so what's the problem?). They are hybrid securities. Neither equity nor debt, they possess characteristics of both, and carry unique risks that cannot be ignored, but are often woefully misunderstood. The first and only book of its kind, The Handbook of Hybrid Securities dispels the many myths and misconceptions about hybrid securities and arms you with a quantitative, practical approach to dealing with them from a valuation and risk management point of view.
* Describes a unique, quantitative approach to hybrid valuation and risk management that uses new structural and multi-factor models
* Provides strategies for the full range of hybrid asset classes, including convertible bonds, preferreds, trust preferreds, contingent convertibles, bonds labeled \"additional Tier 1,\" and more
* Offers an expert review of current regulatory climate regarding hybrids, globally, and explores likely political developments and their potential impact on the hybrid market
* The most up-to-date, in-depth book on the subject, this is a valuable working resource for traders, analysts and risk managers, and a indispensable reference for regulators
eBook
It takes two to Tango: Estimation of the zero-risk premium strike of a call option via joint physical and pricing density modeling
It is generally said that out-of-the-money call options are expensive and one can ask the question from which moneyness level this is the case. Expensive actually means that the price one pays for the option is more than the discounted average payoff one receives. If so, the option bears a negative risk premium. The objective of this paper is to investigate the zero-risk premium moneyness level of a European call option, i.e., the strike where expectations on the option's payoff in both the P- and Q-world are equal. To fully exploit the insights of the option market we deploy the Tilted Bilateral Gamma pricing model to jointly estimate the physical and pricing measure from option prices. We illustrate the proposed pricing strategy on the option surface of stock indices, assessing the stability and position of the zero-risk premium strike of a European call option. With small fluctuations around a slightly in-the-money level, on average, the zero-risk premium strike appears to follow a rather stable pattern over time.
Journal Article
Conic coconuts: the pricing of contingent capital notes using conic finance
In this paper we introduce a fundamental model under which we will price contingent capital notes using conic finance techniques. The model is based on more realistic balance-sheet models recognizing the fact that asset and liabilities are both risky and have to be treated differently taking into account bid and ask prices in a prudent fashion. The underlying theory makes use of conic finance which is based on the concept of acceptability and distorted expectations. We recall the theory and give a brief overview of the related literature. Next, we discuss and propose some potential funded and unfunded contingent capital notes. Traditionally, the conversion trigger of contingent capital notes is in terms of the Core-Tier 1 ratio. We argue that this ratio is maybe not optimal, certainly when taking into account the presence of risky liabilities. As an alternative we introduce triggers based on capital shortfall. The pricing of seven variations of funded as well as unfunded notes is overviewed. We further investigate the effect of the dilution factor and the grace factor. In an appendix we show conic balance sheets including contingent capital instruments.
Journal Article
The Handbook of Hybrid Securities
Introducing a revolutionary new quantitative approach to hybrid securities valuation and risk management
To an equity trader they are shares. For the trader at the fixed income desk, they are bonds (after all, they pay coupons, so what's the problem?). They are hybrid securities. Neither equity nor debt, they possess characteristics of both, and carry unique risks that cannot be ignored, but are often woefully misunderstood. The first and only book of its kind, The Handbook of Hybrid Securities dispels the many myths and misconceptions about hybrid securities and arms you with a quantitative, practical approach to dealing with them from a valuation and risk management point of view.
* Describes a unique, quantitative approach to hybrid valuation and risk management that uses new structural and multi-factor models
* Provides strategies for the full range of hybrid asset classes, including convertible bonds, preferreds, trust preferreds, contingent convertibles, bonds labeled \"additional Tier 1,\" and more
* Offers an expert review of current regulatory climate regarding hybrids, globally, and explores likely political developments and their potential impact on the hybrid market
* The most up-to-date, in-depth book on the subject, this is a valuable working resource for traders, analysts and risk managers, and a indispensable reference for regulators
eBook
Heston Model: The Variance Swap Calibration
This paper features a market implied methodology to infer adequate starting values for the spot and long-run variances and for the mean reversion rate of a calibration exercise under the Heston model. More particularly, these initial parameters are obtained by matching the term structure of the future expected total variance, inferred from the volatility surface, with the model term structure. In the numerical study, we compare the goodness of fit and the parameter stability of the Heston model calibrated by using either plausible random or market implied starting values for a one-year sample period including the recent credit crunch. In particular, we show that the proposed methodology avoids getting stuck in one “bad” local minimum and stabilizes the calibrated parameters through time.
Journal Article
Calibration risk: Illustrating the impact of calibration risk under the Heston model
It is already well documented that model risk is an important issue regarding the pricing of exotics (see Schoutens et al., in A perfect calibration! Now what?, Wilmott Magazine, March 2004: pp 66–78,
2004
). Arguments have been made to put this into the perspective of bid-ask pricing using the theory of conic finance and pricing to acceptability (Cherny and Madan Review of Financial Studies, 22: 2571–2606,
2009
). In this paper we show also the presence and importance of calibration risk. More particularly, we point out that a variety of plausible calibration methods lead again to serious price differences for exotics and different distributions of the P&L of the delta-hedging strategy. This is illustrated under the popular Heston stochastic volatility model, which is used among practitioners to price all kinds of exotic and structured products. This paper shows that it is prudent to take some additional safety margin into account for the pricing of these structured notes.
Journal Article