Module 6 - Credit Products & Risk

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Credit risk plays an important role in the financial markets, and this module will teach you the major products and most important current models essential to quant finance. The modeling approaches instructed here include the structural and the reduced form as well as copulas.

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Sections

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Introduction to Credit Derivatives & Structural Models

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  • Introduction to credit risk 
  • Modelling credit risk
  • Basic structural models: Merton Model, Black and Cox Model
  • Advanced structural models

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Credit Default Swaps

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  • An Introduction to CDS
  • Default Modelling Toolkit. Inhomogenous Poisson Process
  • CDS Pricing: Basic and Advanced Models
  • Bootstrapping intensity from CDS market quotes
  • Accruals and upfront premium in CDS pricing

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Intensity Models

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  • Modelling default by Poisson Process
  • Relationship between intensity and arrival time of default
  • Risky bond pricing: constant vs. stochastic hazard rate
  • Bond pricing with recovery
  • Theory of affine models
  • Affine intensity models and use of Feynman-Kac
  • Two-factor affine intensity model example: Vasicek

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CDO & Correlation Sensitivity

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  • CDO market pricing and risk management
  • Loss Function and CDO Pricing Equation
  • Motivation from loss distribution
  • What is Copula Function
  • Classification of Copula Functions
  • Simulating via Gaussian Copula
  • 3 Gaussian Copula Factor mode
  • The meaning of correlation. Intuition and timescale
  • Linear Correlation and its misuse
  • Rank Correlation
  • Correlation in exotic options
  • Uncertain correlation model for Mezzanine tranche
  • Compound (implied) correlation in Loss Distribution

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X-Valuation Adjustment (CVA, DVA, FVA, MVA) Theory

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  • Historical development of OTC derivatives and xVA
  • Credit and debt value adjustments (CVA and DVA)
  • Funding value adjustment (FVA)
  • Margin and Capital Value Adjustments (MVA and KVA)
  • Current market practice and application

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X-Valuation Adjustment (CVA, DVA, FVA, MVA) Implementation

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  • Implementation of counterparty credit valuation adjustment (CVA)
  • Review the numerical methodologies currently used to quantify CVA in terms of exposure and Monte Carol simulation and the Libor Market Model
  • Illustrate this methodology as well as DVA, FVA and others

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Lecture order and content may occasionally change due to circumstances beyond our control; however this will never affect the quality of the program.

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Fixed Income
Advanced Electives