Numerix Blog

Pricing and Hedging Overnight Index Swaps: Two Possible Approaches

The following article is based on a webinar presented on September 22, 2010, by Jon Zucker, Ph.D. – VP Client Solutions Group. You can access the replay here.

It might seem strange to think about using advanced techniques for modeling Overnight Index Swaps (OIS), since the risk in a typical short-dated OIS is relatively small compared to a bond or 30-yr interest rate swap (IRS). However, there are specific peculiarities about the OIS market that argue for careful consideration of valuation and risk measurement of these instruments.

We present two approaches to tackling this challenge. If you simply want to quantify risk or trade long-dated OIS, a simplified method based closely on the IRS market is likely good enough. But if you need to price and hedge short-dated instruments, it becomes more important to use more sophisticated (and potentially somewhat subjective) processes that provide a closer reflection of real-world market dynamics to produce results that are accurate for trading purposes.

Before diving deeper into valuation methodologies, it’s important to have an understanding of the OIS market and why it’s different from the IRS market.

Implementing Change in Derivatives Regulations

You know changes are coming. You know they’re going to be big. What do you do while you wait?

And how do you handle it when the regulators making the changes don’t exactly know how they’re going to do it?

These questions and more were at the forefront of our recent panel discussion during Microsoft’s “Week on Wall Street.” The panel—“Implementing Changes in Derivatives Regulation”—featured top risk professionals from leading financial and technology companies to discuss how the new regulatory environment is impacting the OTC landscape.

Panelists (L-R): Mike Herskovitz (CIO, AllianceBernstein), Kevin Samborn (Dir. Risk Analytics, Sapient Global Markets), Satyam Kancharla (SVP Client Solutions Group, Numerix), Ricardo Martinez (Principal – Enterprise Risk Services, Deloitte & Touche), Sanjay Sharma (CRO Global Arbitrage & Trading, RBC Capital Markets)

From a risk management perspective, the biggest question lies not in the high-volume liquid market that makes up the vast majority of the OTC market, but in the world of bespokes and structured notes like ABS and MBS.

When you consider the complexity of something like a CDO-squared—thousands of payment streams packaged in an MBS, groups of MBS wrapped up in a CDO and sold in tranches, wrapped up again in another CDO—the task of accurately valuing a security like this is daunting. Then apply analytics to these to calculate DV01 or VaR, plus the impact of credit exposure to hundreds of counterparties.

Technology requirements for companies that trade OTC products have expanded dramatically to enable analytics that are more granular, transparent and consistent. Fortunately, the panelists indicated, the price levels to build these services are much more feasible, helping to partially offset the expense and complexity of the underlying challenges.

It is also helping that institutions are recognizing the value of using consistent models, both across asset classes and across companies.

(In a related note, our recent webinar with Microsoft on high-performance analytics showed how it was possible to implement separate testing, QA and production environments for complex, data-intensive analytics at a price point that was orders-of-magnitude lower than previous architectures.)

Are there certain types of OTC products are simply too complex to trade? The general feeling was that there are opportunities in every market, but the key is being able to understand and explain the rationale behind your valuations.

Numerix Risk Panel: Implementing Change in Derivatives Regulation (Wed 9/22)

Next Wednesday, we will be hosting a panel of expert practitioners in the fields of risk management and technology to discuss the challenges companies face in the wake of recent regulatory changes. The focus will cover both the conceptual and practical aspects of measuring performance of credit and market risk management from the perspective of banks, asset managers, consulting firms and technology providers. 

Cocktails will be served starting at 5:30pm, followed by the panel at 6:00pm, which will last approximately one hour. 

Topics will include:

 

• The use of quantitative measures, such as economic capital, various types of VaR (Stressed, Historical, Monte Carlo) and stress-case scenarios
• The importance accurately measuring liquidity risk
• Implications for capital adequacy in light of recent Basel Committee guidelines
• How technology is responding to meet increasingly sophisticated risk needs 

 

Panelists:

 

• Mike Herskovitz, CIO, AllianceBernstein
• Satyam Kancharla, SVP, Client Solutions Group, Numerix
• Ricardo Martinez, Principal – Enterprise Risk Services, Deloitte & Touche LLP
• Kevin Samborn, Director of Risk Analytics, Sapient Global Markets
• Sanjay Sharma, Chief Risk Officer/Global Arbitrage & Trading, RBC Capital Markets 

 

Location:
Microsoft New York (thanks to our partners at Windows HPC)
1290 Ave of the Americas (near 52nd St)
6th Floor
New York City

Date/Time:
Wednesday, September 22, 2010
5:30pm (6:00pm panel)

Introducing the Numerix Office in Seoul

We recently opened a new office in downtown Seoul to support the growing demand for advanced pricing and risk analytics in South Korea. This move will allow us to provide even better quantitative and sales support at the local level.

As a symbol of our strategic commitment to the Asian market, the opening marks another important achievement in the region, including:

• Signing the first direct customer in South Korea: Hana Daetoo Securities
• Implementing Numerix Bloomberg Edition and Numerix CrossAsset SDK running on Windows HPC Server 2008 at Samsung Securities, a top South Korean investment banking and brokerage firm
• Partnering with Nomura Research Institute, the largest IT consulting firm in Japan
• Signing the first asset management client in Japan to use Numerix CrossAsset for pricing and risk
• Launching a localized corporate website for Japan (www.numerix.jp)

Our Seoul office can be reached at:

Phone: +822 3782 4930
Fax: +822 3782 4555
Local Contact: Jinwoo Park, VP
Email: jinwoo.park@numerix.com

21F Seoul Finance Center
84 Taepyeongro 1-ga Jung-gu
Seoul, Korea 100-769