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13

The limitations of the Gaussian copula were well-known among the quantitative finance practitioners before the crisis. See this paper by D. Brigo. To answer the question: no "fat tails" unable to fit the market prices without tweaks (base correlation) which make the model arbitrageable it's a static model (e.g. forward-starting tranches are impossible to ...


10

Value has traditionally been one of the most important stock-selection signals for quantitative managers. However, since the late 2000s, following a rapid flow into quantitative investing, traditional value strategies have lost most of their predictive power and the returns generated from them have also become more volatile. The typical approach of ...


9

If you want a 'pop science' account for it, the Wired article by Felix Salmon is a pretty good start. If you want harder technical stuff, well then you can start at the Wikipedia article and its section on Applications and follow the references: [...] Some believe the methodology of applying the Gaussian copula to credit derivatives to be one of ...


7

There are "perpetual" bonds and preferred shares that are traded in the corporate credit markets that exactly match your conditions above. They are recorded in the 10-K at notional value $X$. The "close-out" feature is an embedded call. You should assume your favorite stochastic interest rate (and/or credit) model and run a PDE solver, tree, or other grid ...


7

Most counterparty agreements specify some sort of ois rate for the interest paid/received on posted collateral. So the OIS rate is the appropriate one to use for discounting future cash flows. Prior to 2008 the OIS/Libor spread was small and stable, so you didn't really need to worry about this, but now it's much larger, so people are taking it into ...


6

I can't speak for all structured products but valuing a MBS is straight-forward, but not easy. It's straight-forward because you just need to calculate the net present value of the discounted cash flows. That said, accurately determining those cash flows is hard. The most difficult cash flows to determine--prepayments and defaults/severity--also have the ...


5

You should use the full yield curve, discounting cash flows at specific dates using the appropriate zero-coupon interest rate. As to which yield curve, that is often a matter of convention. Generally one uses the LIBOR/swaps curve for all but the most liquid products (in which case you use the treasury curve). The curve is constructed from LIBOR/Eurodollar ...


4

Why does USD based security valuation have to give a thing about what London Banks think? Your question is based on false premises: the USD Libor is not determined by polling London based banks as you seem to believe, but banks on the London money market. The difference is important, as there are—of course—banks which are not based in London and active ...


4

To create such a model, you'd start with some data, and then start fitting curves to it. For example, let's take a company where there are reasonable consensus forecasts about the next few years' earnings; and let's assume you've got some time-series data on changes in those consensus forecasts, and changed in the price. You could then fit a model based on ...


4

You are essentially dealing with two options: $EU\,{Warrant}(S_t) = BlackScholesCall(S_t)+CompoundCall(S_t)$ The Black-Scholes formula is known, and Compound Option pricing has various approaches in research which you may find.


3

A paper by Gong, Smith, and Zou (2007) addresses your question exactly. From the abstract: This paper explores the implications of hyperbolic discounting for asset prices and rates of return. Hyperbolic discounting has no effect on the equity premium. However, by making people less patient, causes stock prices to be lower, and interest rates ...


3

I wouldn't put too much faith in IBES forecasts. You may remember this situation: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=889322 (In case the above link doesn't work, Google "Rewriting History Alexander Ljungqvist"). You'll find lots of excuses for worthless forecasts: http://www.princeton.edu/~hhong/rje-analyst.pdf Below is a graph that I ...


3

Take a look at Campbell's 2008 paper "Predicting Excess Stock Returns out of Sample". This paper is in response to Goyal & Welch's paper which argued that excess returns cannot be predicted out of sample. Also see Baekart and Ang's paper "Stock Return Predictability: Is it there?". A good theoretical framework that ties stock return predictability to ...


3

A condition for correct calibration of the short rate model is that it exactly reproduce the present values of fixed (option-free) cashflows - that is, that it give the same answer as ordinary discounting at the spot rate. If it doesn't, you've done something wrong - sort of like using a model that violates put-call parity. (Actually, it's exactly like ...


3

Depends on circumstances - if you just trade futures intraday for yourself, secondary market T-bills (http://www.federalreserve.gov/releases/h15/data.htm#fn3) will be good enough.


2

Mortgage backed securities are valued by calculating the net present value (NPV) of cash flows they are expected to generate. These cash flows are predicted using a model that incorporates all the contractual characteristics of the security and the underlying loans, as well as assumptions on things like prepayment speed, default speed, loss severity, and ...


2

The framework for valuing structured finance products in general is based on the nature of the cashflows in the product. Decompose the constituent components of the structure. Make some choices about handling the correlations between assets in the structure. Review the covenants of the structure and their impact on the cashflows (sequence of events). ...


2

The OIS rate is more stable than Libor, right? And according to this article from Risk Magazine: The party that is owed money at the end of the swap will have been paying an OIS rate on the collateral it has been holding, and so the ultimate value of the cash it will receive will be the sum it is owed minus the overnight interest rate it has had to pay ...


2

If you assume that you do not have any market risk (a strange assumption, but it would hold for example if you are fully hedged), then a (correctly) collaterlized derivative does not have any net future cash flow. Clearly: if the derivative contract has a cash flow of -X, its value will go down by X and the collateral account will have a cash flow of +X (the ...


2

You will find elaborate answers to your question in this excellent new book: Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors by Gray & Carlisle You can find a good summary over at CXO Advisory Group: A Few Notes on Quantitative Value


2

The importance here is that it actually does not matter in what time zone or market the libor rates are set. Key is that it is supposed (!!!) to be a gauge at what rate contributing banks could borrow funds at in the inter-bank market. Like you can go to any African country and borrow or lend US dollar, so can any Japanese, European, or American bank borrow ...


2

I think the formula you refer to is $$ PV=\frac{C}{r-g} $$ If that's the case, then you do not subtract growth, the minus sign has an advantage on the present value. The initial formula $PV=\frac{C}{r}$ assumes no evolution in $C$, but the other one assumes the that the payment will grow in time hence yes, you get paid for that.


1

Hyberbolic discounting seems to be operative in "bear" or panicked markets. That's when utilities, and other companies with heavily "front ended" earnings do relatively well, while cyclicals do poorly. People "know" that the cyclicals will (probably) do well some day, but they discount "delayed" earnings that will follow poor near term ones more heavily than ...


1

There was an error in your expected value, which I have corrected - the probabilities and the binomial coefficient (the "N choose k") should not be raised to the power $c$. With that correction, it is a simple application of the Binomial theorem: \begin{eqnarray} \left(u^cq+d^c(1−q)\right)^N&=&\sum_{j=0}^N {N \choose j}(u^cq)^{j}(d^c(1−q))^{N-j}\\ ...


1

According to this reference there are indeed several types of P/E-Ratios (trailing P/E that is based on previous earnings and forward P/E which is based on projected earnings) Also several books calculate the P/E according to the following formula $P/E-Ratio = \frac{Average Common Stock Price}{Net Income Per Share}$ (Confer source1, source2 and source3) ...


1

If you don’t have any market quotes, one possible way to assess the credit risk of a company is to use its financial statement information in order to infer the corporate rating that credit agencies might have assigned to such company. For instance, in this paper you can find the general criteria that S&P use to derive the credit rating of a company ...


1

Alright, here's the proof (I think): Statement of APT: $$E(r_a)=r_f + \displaystyle\sum_{i=1}^n\lambda_i * cov(E(r_a), r_i)$$ Expand $E(r_a)$: $$\frac{E(C_1)}{PV_0} - 1 =r_f + \displaystyle\sum_{i=1}^n\lambda_i * cov(\frac{E(C_1)}{PV_0} - 1, r_i)$$ Since $PV_0$ doesn't have any covariance with $r_i$, we can reduce the above to the following: ...


1

Nearly every options trader - and every options marketmaker - will hedge their derivatives exposure by trading the underlying. So even if I buy a set of naked calls, my counterparty (e.g. whoever is writing me the options, usually a hedge fund or a bank) will have negative exposure to the stock and buy it to cancel out their risk. Think of an option as ...


1

I would normalize valuation variables over the business cycle. These normalized variables exhibit mean-reversion. For example, use price-to-peak earnings rather than P/E. Here is a good illustration of the idea.



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