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See detailA Markov-switching Generalized additive model for compound Poisson processes, with applications to operational losses models
Hambuckers, julien ULiege; Kneib, Thomas; Langrock, Roland et al

in Quantitative Finance (in press)

This paper is concerned with modeling the behavior of random sums over time. Such models are particularly useful to describe the dynamics of operational losses, and to correctly estimate tail-related risk ... [more ▼]

This paper is concerned with modeling the behavior of random sums over time. Such models are particularly useful to describe the dynamics of operational losses, and to correctly estimate tail-related risk indicators. However, time-varying dependence structures make it a difficult task. To tackle these issues, we formulate a new Markov-switching generalized additive compound process combining Poisson and generalized Pareto distributions. This flexible model takes into account two important features: on the one hand, we allow all parameters of the compound loss distribution to depend on economic covariates in a flexible way. On the other hand, we allow this dependence to vary over time, via a hidden state process. A simulation study indicates that, even in the case of a short time series, this model is easily and well estimated with a standard maximum likelihood procedure. Relying on this approach, we analyze a novel dataset of 819 losses resulting from frauds at the Italian bank UniCredit. We show that our model improves the estimation of the total loss distribution over time, compared to standard alternatives. In particular, this model provides estimations of the 99.9% quantile that are never exceeded by the historical total losses, a feature particularly desirable for banking regulators. [less ▲]

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See detailCurrency Total Return Swaps: Valuation and Risk Factor Analysis
Cuchet, Romain; François, Pascal; Hübner, Georges ULiege

in Quantitative Finance (2013), 13(7), 1135-1148

Currency total return swaps (CTRS) are hybrid derivatives instruments that allow to simultaneously hedge against credit and currency risks. We develop a structural credit risk model to evaluate CTRS ... [more ▼]

Currency total return swaps (CTRS) are hybrid derivatives instruments that allow to simultaneously hedge against credit and currency risks. We develop a structural credit risk model to evaluate CTRS premia. Empirical test on a sample of 23,005 price observations from 59 underlying issuers yields an average percentage error of around 10%. This indicates that, beyond interest rate risk, firm-specific factors are major drivers of the variations in the valuation of these instruments. Regression analysis of residuals shows that exchange rate determinants account for up to 40% of model pricing errors — indicating that a currency risk premium affects the CTRS price significantly but only marginally, which confirms the prevalence of credit risk in the pricing of CTRS. [less ▲]

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See detailBlock bootstrap methods and the choice of stocks for the long run
Cogneau, Philippe ULiege; Zakamouline, Valeri

in Quantitative Finance (2013), 13

Financial advisors commonly recommend that the investment horizon should be rather long in order to benefit from the ‘time diversification’. In this case, in order to choose the optimal portfolio, it is ... [more ▼]

Financial advisors commonly recommend that the investment horizon should be rather long in order to benefit from the ‘time diversification’. In this case, in order to choose the optimal portfolio, it is necessary to estimate the risk and reward of several alternative portfolios over a long-run given a sample of observations over a short-run. Two interrelated obstacles in these estimations are lack of sufficient data and the uncertainty in the nature of the return generating process. To overcome these obstacles researchers rely heavily on block bootstrap methods. In this paper we demonstrate that the estimates provided by a block bootstrap method are generally biased and we propose two methods of bias reduction. We show that an improper use of a block bootstrap method usually causes underestimation of the risk of a portfolio whose returns are independent over time and overestimation of the risk of a portfolio whose returns are mean-reverting. [less ▲]

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