This book provides a comprehensive guide for modern derivatives pricing and credit analysis. Written to provide sound theoretical detail but practical implication, it provides readers with everything they need to know to price modern financial derivatives and analyze the credit exposure of a financial instrument in today's markets.

'The authors are established practitioners with many years of quant development and implementation experience in leading financial institutions. This is well reflected in the present book, rich with useful examples and covering highly relevant topics such as (among many others) real world RFE models and backtesting, normally left out by the main-stream financial literature.'

-Fabrizio Anfuso, Head of Collateralized Exposure Modelling, Credit Suisse; Visiting Lecturer, ETH Zurich and Bocconi University Milan

"The authors have achieved a matchless combination of theoretical and most importantly, practical expertise to this book. The work is complete, insightful and exact and is suitable for all professionals dealing with XVA expert and novice alike."

-Jörg Kienitz, Director and Co-Lead Quant Unit and Adjunct Associate Professor University of Cape Town

'Modern Derivatives Pricing and Credit Exposure Analysis by Lichters, Stamm and Gallagher (with whom I have collaborated) has unique strengths. There are three chapters developing discounting from a CCP point of view, a global view and a CSA-based view. There is a fully worked out multi-asset framework based on the Linear Gaussian Model (LGM) with particular depth on inflation with both Jarrow-Yildrim and Dodgson-Kainth models. It provides a forensically detailed analysis of credit processes, mapping their limitations and highlights directions that avoid them (developed in detail from thePeng-Kou approach). The XVA coverage starts with CVA/DVA and is followed by separate chapters on FVA and KVA. The usual limitations for such a comprehensive book are present, e.g. limited treatment of smile modelling in a multi-curve setup (worth a book by itself), and limited coverage of the trade-offs in XVA between the costs of hedging risks and the (capital and modelling) costs of open risks (often forced by credit market limitations). Overall, this is a thorough and practical introduction to modern derivatives pricing."

-Chris Kenyon, front office quant; author of 10 papers in the Cutting Edge section in Risk

Autorentext
Roland Lichters has headed bank Risk and IT departments building teams, processes, pricing/risk methodologies and systems. As founding Partner of Quaternion Risk Management, responsible for R&D, he focusses besides his consulting and advisory work on the company's QuantLib-based pricing and risk analytics products, implementing the methods covered in this book. Roland holds a PhD and Diploma in Physics and lectures part-time in Financial Engineering at Trinity College Dublin.

Roland Stamm held senior positions in a number of banks' IT and Risk Management departments before joining Quaternion Risk Management as a Partner. In his banking work, he focused on market and credit risk methodology as well as the pricing and risk management of complex financial products. Roland holds a PhD in Mathematics and is co-author of the book Discounting, LIBOR, CVA and Funding (with Chris Kenyon) as well as a part-time lecturer.

Donal Gallagher is a founding Partner and Managing Director of Quaternion Risk Management and advises CFOs and CROs on the transparent pricing, risk and capital management of complex financial instruments. His research interests include default models and portfolio credit products. Donal holds a PhD from the California Institute of Technology in Applied Mathematics and lectures part time in Financial Engineering at Trinity College Dublin.

Inhalt

Contents
Preface
Acknowledgments
PART I: DISCOUNTING

Discounting Before the Crisis
1.1 The Risk-Free Rate
1.2 Pricing Linear Instruments
1.2.1 Forward Rate Agreements
1.2.2 Interest Rate Swaps
1.2.3 FX Forwards
1.2.4 Tenor Basis Swaps
1.2.5 Cross-Currency Basis Swaps
1.3 Curve Building
1.4 Pricing Non-Linear Instruments
1.4.1 Caps and Floors
1.4.2 Swaptions
2 What ChangedWith the Crisis
2.1 Basis Products and Spreads
2.1.1 Tenor Basis Swaps
2.1.2 Cross-Currency Basis Swaps
2.2 Collateralization
3 Clearing House Pricing
3.1 Introduction of Central Counterparties
3.2 Margin Requirements
3.3 Building the OIS Curve
3.4 USD Specialties
3.5 Building the Forward Projection Curves
3.6 More USD Specialties
3.7 Example: Implying the Par Asset Swap Spread
3.8 Interpolation
3.9 Pricing Non-Linear Instruments
3.9.1 European Swaptions
3.9.2 Bermudan Swaptions
3.10 Not All Currencies Are Equal
4 Global Discounting
4.1 Collateralization In a Foreign Currency
4.2 Non-Rebalancing Cross-Currency Swaps
4.3 Rebalancing Cross-Currency Swaps
4.4 Examples: Approximations of Basis Spreads
4.4.1 Tenor Basis Spreads
4.4.2 Flat Cross-Currency Swaps
4.4.3 OIS Cross-Currency Basis Spread
4.4.4 LIBOR Cross-Currency Basis Spread
5 CSA Discounting
5.1 ISDA Agreements and CSA Complexities
5.2 Currency Options
5.3 Negative Overnight Rates
5.4 Other Assets as Collateral
5.5 Thresholds and Asymmetries
5.6 Some Thoughts on Initial Margin
6 Fair Value Hedge Accounting
6.1 Introduction
6.2 Hedge Effectiveness
6.3 Single-Curve Valuation
6.4 Multi-Curve Valuation
PART II: CREDIT AND DEBIT VALUE ADJUSTMENT
7 Introduction
8 Fundamentals
8.1 Unilateral CVA
8.2 Bilateral CVA
9 Single Trade CVA
9.1 Interest Rate Swap
9.1.1 Exercise within interest periods
9.1.2 Amortizing Swap
9.1.3 A Simple Swap CVA Model
9.2 Cash-Settled European Options
9.3 FX Forward
9.4 Cross-Currency Swap
9.5 Rebalancing Cross-Currency Swap
PART III: RISK FACTOR EVOLUTION
10 A Monte Carlo Framework
11 Interest Rates
11.1 Linear Gauss Markov Model
11.1.1 Multiple Curves
11.1.2 Invariances
11.1.3 Relation to the Hull-White model in T-Forward Measure
11.2 Products
11.2.1 Zero Bond Option
11.2.2 European Swaption
11.2.3 Bermudan Swaption with Deterministic Basis
11.2.4 Stochastic Basis
11.3 CSA Discounting Revisited
11.4 Exposure Evolution Examples
12 Foreign Exchange
12.1 Cross-Currency LGM
12.2 Multi-Currency LGM
12.3 Calibration
12.3.1 Interest Rate Processes
12.3.2 FX Processes
12.3.3 Correlations
12.4 Cross-Currency Basis
12.5 Exposure Evolution Examples
13 Inflation
13.1 Products
13.2 Jarrow-Yildirim Model
13.2.1 Calibration
13.2.2 Foreign Currency Inflation
13.3 Dodgson-Kainth Model
13.3.1 Calibration
13.3.2 Foreign Currency Inflation
13.4 Seasonality
13.5 Exposure Evolution Examples
14 Equity and Commodity
14.1 Equity
14.2 Commodity
15 Credit
15.1 Market
15.2 Gaussian Model
15.2.1 Conclusion
15.3 Cox-Ingersoll-Ross Model
15.3.1 CIR without Jumps
15.3.2 Relaxed Feller Constraint
15.3.3 CDS Spread Distribution
15.3.4 CIR with Jumps: JCIR
15.3.5 JCIR Extension
15.3.6 Examples: CDS CVA and Wrong-Way Risk
15.3.7 Conclusion
15.4 Black-Karasinski Model
15.5 Peng-Kou Model
15.5.1 Review CDS and CDS Option
15.5.2 Compound Poisson Process
15.5.3 Compound Polya Process
15.5.4 Examples
15.5.5 Conclusion
PART IV: XVA 251
16 Cross-Asset Scenario Generation
16.1 Expectations and Covariances
16.2 Path Generation
16.3 Pseudo Random vs Low Discrepancy Sequences
16.4 Long-Term Interest Rate Simulation
17 Netting and Collateral
17.1 Netting
17.1.1 Non-netted Counterparty Exposures
17.1.2 Netting Set Exposures
17.1.3 Generalized Counterparty Exposures
17.2 Collateralization
17.2.1 Collateralized Netting Set Exposure
17.2.2 CSA Margining
17.…