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Advanced Interest Rate Modelling (Part 2)

The Quants Hub (part of the WBS Training group) is a comprehensive online resource for Quantitative Analysts, Risk Managers, Structuring and Trading Desks, Model Validation, Programmers & Developers & Financial Engineers that combines video training from world-renowned expert instructors with a rich library of content for self-paced, distance learning. This platform empowers you and your institution to create an individualised bespoke educational library resource.

Advanced Interest Rate Modelling (Part 2)

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Course Running Time: 3 Hours 30 Minutes

Course Outline:

Managing Exotics:  (Running Time: 1.01:14)

Practical Pricing of Exotics & Adjustors and risk migration: (Running Time: 1.24:07)

Pricing callable range notes (accrual options): (Running Time: 53:54)

About the Presenter:

Pat Hagan: Consultant & Mathematics Institute, Oxford University

Pat Hagan received his BS and Phd from the California Institute of Technology, where he graduated at the top of his class. Before entering banking, he designed chemical reactors for Exxon and did physics research at Los Alamos. He specializes in designing trading systems, as well as developing the component models, calibration methods, and numerical algorithms. He has created several industry standard models and methodologies, including the SABR and LGM models, autocalibration, and adjustors.

Managing Exotics

  • Three elements to modern pricing: model, calibration, and evaluation
  • Choosing a model and the five main interest rate risks
  • HJM models – strengths, weaknesses, usage
  • BGM/LMM models – strengths, weaknesses, usage
  • Short rate models – strengths, weaknesses, usage
  • Markovian models – strengths, weaknesses, usage

Practical Pricing of Exotics

  • LGM model
  • Closed form zero coupon bond and swaption prices under the LGM model
  • Callable swaps (Bermudans)
  • Calibration strategies and the selection of calibration instruments
  • Forward volatility risk
  • How the risks, hedges, and values of the exotic depend on the calibration instruments

Adjustors and risk migration

  • Classic mis-hedging problem
  • Risk migration and the adjusted price
  • The adjusted price
  • Examples

Pricing callable range notes (accrual options)

  • Standard range note
  • Using replication to price the non-callable range notes. Convexity adjustments
  • Pricing requirements
  • Libor market model vs. external adjustors vs. internal adjustors
  • Using internal adjustors with the LGM modle
  • Pricing, risk analysis, and hedging the embedded and external options
  • General procedure for callables with embedded options