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Rating Contingent Credit Default Swap Internal Trade Review

Rating Contingent Credit Default Swap Internal Trade Review. Stanley Securities September 23, 2010 David Lin Shengbao Luo Casey Wang George Wang Peilin Zhang. Agenda. Valuation & Calibration Market Risk Hedging Model Risk P&L. Valuation Overview. Discount factors

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Rating Contingent Credit Default Swap Internal Trade Review

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  1. Rating Contingent Credit Default SwapInternal Trade Review Stanley Securities September 23, 2010 David Lin ShengbaoLuo Casey Wang George Wang Peilin Zhang

  2. Agenda • Valuation & Calibration • Market Risk • Hedging • Model Risk • P&L

  3. Valuation Overview • Discount factors • Pricing default contingent cash flows with hazard rate process • Hazard rate model calibration and parameter selection • Spot FX modeling and FX Forward payoff valuation • Downgrade threshold determination

  4. Pricing Default Contingent Cash Flows PV at time t: And continue backwards, or:

  5. Hazard Rate Process Calibration Calculation parameters • Calibrated parameters: h0, θ • Fixed parameters: α, v(ht,t) Simulation Parameters • Time step • Number of paths

  6. Hazard Rate Calibration Cont. Model Parameters:

  7. Downgrade threshold 0.012

  8. RCCDS Pricing Results

  9. Market Risk

  10. Hedging Dynamic delta hedging as part of the credit hybrids portfolio • UJB credit risk • FX delta • IR PV01 • Cross partials

  11. Model Risk • Reduce-form model • OU hazard rate process: • rate can be negative, and can be different from the real process • Model assumptions: • alpha, sigma, ratings downgrade hazard rate • Coarseness of time steps • Knock in knock out between steps

  12. How much $ will we make? • Fair market value: $1.34MM • Offer market value: $1.60MM • Day one hedging cost: $32K • Day one P&L: $228K

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