Handbook of Fixed-Income Securities by Pietro Veronesi (English) Hardcover Book

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A comprehensive guide to the current theories and methodologies intrinsic to fixed-income securities Written by well-known experts from a cross section of academia and finance, Handbook of Fixed-Income Securities features a compilation of the most up-to-date fixed-income securities techniques and methods.

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A comprehensive guide to the current theories and methodologies intrinsic to fixed-income securities Written by well-known experts from a cross section of academia and finance, Handbook of Fixed-Income Securities features a compilation of the most up-to-date fixed-income securities techniques and methods. The book presents crucial topics of fixed income in an accessible and logical format. Emphasizing empirical research and real-life applications, the book explores a wide range of topics from the risk and return of fixed-income investments, to the impact of monetary policy on interest rates, to the post-crisis new regulatory landscape. Well organized to cover critical topics in fixed income, Handbook of Fixed-Income Securities is divided into eight main sections that feature: • An introduction to fixed-income markets such as Treasury bonds, inflation-protected securities, money markets, mortgage-backed securities, and the basic analytics that characterize them • Monetary policy and fixed-income markets, which highlight the recent empirical evidence on the central banks' influence on interest rates, including the recent quantitative easing experiments• Interest rate risk measurement and management with a special focus on the most recent techniques and methodologies for asset-liability management under regulatory constraints• The predictability of bond returns with a critical discussion of the empirical evidence on time-varying bond risk premia, both in the United States and abroad, and their sources, such as liquidity and volatility • Advanced topics, with a focus on the most recent research on term structure models and econometrics, the dynamics of bond illiquidity, and the puzzling dynamics of stocks and bonds • Derivatives markets, including a detailed discussion of the new regulatory landscape after the financial crisis and an introduction to no-arbitrage derivatives pricing • Further topics on derivatives pricing that cover modern valuation techniques, such as Monte Carlo simulations, volatility surfaces, and no-arbitrage pricing with regulatory constraints • Corporate and sovereign bonds with a detailed discussion of the tools required to analyze default risk, the relevant empirical evidence, and a special focus on the recent sovereign crises A complete reference for practitioners in the fields of finance, business, applied statistics, econometrics, and engineering, Handbook of Fixed-Income Securities is also a useful supplementary textbook for graduate and MBA-level courses on fixed-income securities, risk management, volatility, bonds, derivatives, and financial markets.Pietro Veronesi, PhD, is Roman Family Professor of Finance at the University of Chicago Booth School of Business, where he teaches Masters and PhD-level courses in fixed income, risk management, and asset pricing. Published in leading academic journals and honored by numerous awards, his research focuses on stock and bond valuation, return predictability, bubbles and crashes, and the relation between asset prices and government policies.

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Written by well-known experts from a cross section of academia and finance, Handbook of Fixed-Income Securities features a compilation of the most up-to-date fixed-income securities techniques and methods. The book presents crucial topics of fixed income in an accessible and logical format. Emphasizing empirical research and real-life applications, the book explores a wide range of topics from the risk and return of fixed-income investments, to the impact of monetary policy on interest rates, to the post-crisis new regulatory landscape. Well organized to cover critical topics in fixed income, Handbook of Fixed-Income Securities is divided into eight main sections that feature: * An introduction to fixed-income markets such as Treasury bonds, inflation-protected securities, money markets, mortgage-backed securities, and the basic analytics that characterize them * Monetary policy and fixed-income markets, which highlight the recent empirical evidence on the central banks' influence on interest rates, including the recent quantitative easing experiments * Interest rate risk measurement and management with a special focus on the most recent techniques and methodologies for asset-liability management under regulatory constraints * The predictability of bond returns with a critical discussion of the empirical evidence on time-varying bond risk premia, both in the United States and abroad, and their sources, such as liquidity and volatility * Advanced topics, with a focus on the most recent research on term structure models and econometrics, the dynamics of bond illiquidity, and the puzzling dynamics of stocks and bonds * Derivatives markets, including a detailed discussion of the new regulatory landscape after the financial crisis and an introduction to no-arbitrage derivatives pricing * Further topics on derivatives pricing that cover modern valuation techniques, such as Monte Carlo simulations, volatility surfaces, and no-arbitrage pricing with regulatory constraints * Corporate and sovereign bonds with a detailed discussion of the tools required to analyze default risk, the relevant empirical evidence, and a special focus on the recent sovereign crises A complete reference for practitioners in the fields of finance, business, applied statistics, econometrics, and engineering, Handbook of Fixed-Income Securities is also a useful supplementary textbook for graduate and MBA-level courses on fixed-income securities, risk management, volatility, bonds, derivatives, and financial markets.

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Written by well-known experts from a cross section of academia and finance, Handbook of Fixed-Income Securities features a compilation of the most up-to-date fixed-income securities techniques and methods. The book presents crucial topics of fixed income in an accessible and logical format. Emphasizing empirical research and real-life applications, the book explores a wide range of topics from the risk and return of fixed-income investments, to the impact of monetary policy on interest rates, to the post-crisis new regulatory landscape. Well organized to cover critical topics in fixed income, Handbook of Fixed-Income Securities is divided into eight main sections that feature: * An introduction to fixed-income markets such as Treasury bonds, inflation-protected securities, money markets, mortgage-backed securities, and the basic analytics that characterize them * Monetary policy and fixed-income markets, which highlight the recent empirical evidence on the central banks' influence on interest rates, including the recent quantitative easing experiments * Interest rate risk measurement and management with a special focus on the most recent techniques and methodologies for asset-liability management under regulatory constraints * The predictability of bond returns with a critical discussion of the empirical evidence on time-varying bond risk premia, both in the United States and abroad, and their sources, such as liquidity and volatility * Advanced topics, with a focus on the most recent research on term structure models and econometrics, the dynamics of bond illiquidity, and the puzzling dynamics of stocks and bonds * Derivatives markets, including a detailed discussion of the new regulatory landscape after the financial crisis and an introduction to no-arbitrage derivatives pricing * Further topics on derivatives pricing that cover modern valuation techniques, such as Monte Carlo simulations, volatility surfaces, and no-arbitrage pricing with regulatory constraints * Corporate and sovereign bonds with a detailed discussion of the tools required to analyze default risk, the relevant empirical evidence, and a special focus on the recent sovereign crises A complete reference for practitioners in the fields of finance, business, applied statistics, econometrics, and engineering, Handbook of Fixed-Income Securities is also a useful supplementary textbook for graduate and MBA-level courses on fixed-income securities, risk management, volatility, bonds, derivatives, and financial markets.

Author Biography

Pietro Veronesi, PhD, is Roman Family Professor of Finance at the University of Chicago Booth School of Business, where he teaches Masters and PhD-level courses in fixed income, risk management, and asset pricing. Published in leading academic journals and honored by numerous awards, his research focuses on stock and bond valuation, return predictability, bubbles and crashes, and the relation between asset prices and government policies.

Table of Contents

Notes on Contributors xix Preface xxv Part I Fixed Income Markets 1 1 Fixed Income Markets: An Introduction 3 1.1 Introduction 3 1.2 U.S. Treasury Bills, Notes, and Bonds 7 1.3 Interest Rates, Yields, and Discounting 8 1.4 The Term Structure of Interest Rates 9 1.4.1 The Economics of the Nominal Yield Curve 9 1.4.2 The Expectations Hypothesis 13 1.4.3 Forward Rates as Expectation of Future Interest Rates? 16 1.4.4 Interpreting a Steepening of the Yield Curve 17 1.5 Pricing Coupon Notes and Bonds 17 1.5.1 Estimating the Zero-Coupon Discount Function 18 1.5.2 Data and Bond Illiquidity 19 1.6 Inflation-Protected Securities 19 1.7 Floating Rate Notes 22 1.8 Conclusion 24 References 24 2 Money Market Instruments 25 2.1 Overview of the Money Market 25 2.2 U.S. Treasury Bills 26 2.3 Commercial Paper 27 2.3.1 General Facts about Commercial Paper 27 2.3.2 Nonasset-Backed Commercial Paper 27 2.3.3 Asset-Backed Commercial Paper 28 2.4 Discount Window 29 2.5 Eurodollars 29 2.5.1 Eurodollar Futures 31 2.6 Repurchase Agreements 32 2.6.1 Types of Repos and Haircuts 32 2.6.2 Basic Forms of Repo Collateral 33 2.6.3 Repo Rates and Collateral Value Risks 34 2.6.4 The Run on Repo During the Financial Crisis 34 2.7 Interbank Loans 35 2.7.1 Federal Funds 35 2.7.2 Libor 37 2.7.3 Overnight Index Swaps and LIBOR–OIS Spreads 38 2.7.4 A Model of LIBOR–OIS Spreads 38 2.8 Conclusion 40 References 40 3 Inflation-Adjusted Bonds and the Inflation Risk Premium 41 3.1 Inflation-Indexed Bonds 41 3.1.1 Mechanics of TIPS 42 3.1.2 Valuing an Inflation-Indexed Bond 42 3.2 Inflation Derivatives 42 3.2.1 Constructing a Synthetic Nominal Treasury Bond with Inflation Swaps 42 3.3 No-Arbitrage Pricing 43 3.3.1 Zero-Coupon Bonds 43 3.4 Inflation Risk Premium 43 3.4.1 Determinants of the Inflation Risk Premium 44 3.5 A Look at the Data 45 3.5.1 Break-Even Rates 45 3.5.2 Inflation Swap Rates 46 3.5.3 Inflation Risk Premium 49 3.6 Conclusion 50 3.7 Appendix 50 3.7.1 Breeden–Lucas–Rubinstein Example 50 3.7.2 Disaster Risk 51 3.8 Data Appendix 51 References 52 4 Mortgage-Related Securities (MRSs) 53 4.1 Purpose of the Chapter 53 4.2 Introduction to MRSs 54 4.2.1 Mortgage and Securitization 54 4.2.2 The Cash Flows of Mortgage Pools 55 4.3 Valuation Overview 57 4.3.1 OAS, OAD, and Negative Convexity 58 4.3.2 Modeling Prepayment and Default 60 4.4 Analyzing an MRS 62 4.4.1 Modeling Prepayment and Default 62 4.4.2 Freddie Mac's STACR 67 4.4.3 Analyzing the STACR Series 2013-DN1 71 4.5 Summary 72 References 73 Part II Monetary Policy and Fixed Income Markets 75 5 Bond Markets and Monetary Policy 77 5.1 Introduction 77 5.2 High-Frequency Identification of Monetary Policy Shocks 78 5.2.1 Learning About Monetary Policy Surprises 79 5.2.2 The Impact on Treasury Bond Yields 81 5.2.3 The Timing of Expected Fed Interventions 82 5.3 Target Versus Path Shocks 84 5.3.1 The Economics of FOMC Meetings and Bond Yields 86 5.4 Conclusions 90 References 91 6 Bond Markets and Unconventional Monetary Policy 93 6.1 Introduction 93 6.2 Unconventional Policies: The Fed, ECB, and BOE 94 6.2.1 Federal Reserve Operations 94 6.2.2 Bank of England Operations 96 6.2.3 European Central Bank Operations 97 6.3 Unconventional Policies: A Theoretical Framework 101 6.3.1 Portfolio Balance (Duration) Channel 102 6.3.2 Signaling Channel 103 6.3.3 Credit and Capital Constraint Channel 103 6.3.4 Preferred Habitat and Asset Scarcity Channel 104 6.4 Unconventional Policies: The Empirical Evidence 104 6.4.1 The Treasury Bond Market 104 6.4.2 The MBS Market 113 6.4.3 How Persistent is the Effect? 115 6.5 Conclusions 115 References 116 Part III Interest Rate Risk Management 117 7 Interest Rate Risk Management and Asset Liability Management 119 7.1 Introduction 119 7.2 Literature Review 120 7.3 Interest Rate Risk Measures 120 7.3.1 Duration 121 7.3.2 Convexity 122 7.3.3 Key Rate Duration 123 7.3.4 Principal Component Analysis and Factor Duration 123 7.4 Application to Asset Liability Management 127 7.4.1 Nature of Liabilities 127 7.4.2 Cash Flow Matching 128 7.4.3 Classic Immunization and Duration Matching 130 7.4.4 Key Rate Duration Matching 133 7.4.5 Factor Duration Matching 137 7.5 Backtesting ALM Strategies 141 7.6 Liability Hedging and Portfolio Construction 142 7.7 Conclusions 144 7.8 Appendix: The Implementation of Principal Component Analysis 145 References 146 8 Optimal Asset Allocation in Asset Liability Management 147 8.1 Introduction 147 8.2 Yield Smoothing 150 8.3 ALM Problem 151 8.3.1 Return and Yield Dynamics 152 8.3.2 Preferences 153 8.3.3 Constraints 154 8.3.4 Data Description and Estimation 155 8.4 Method 155 8.5 Single-Period Portfolio Choice 156 8.5.1 ALM with a VaR Constraint 156 8.5.2 ALM with AFCs 158 8.6 Dynamic Portfolio Choice 160 8.6.1 Welfare and Portfolio Implications of Yield Smoothing 160 8.6.2 Hedging Demands and Regulatory Constraints 161 8.7 Conclusion 164 8.8 Appendix: Return Model Parameter Estimates 165 8.9 Appendix: Benchmark Without Liabilities 165 References 166 Part IV the Predictability of Bond Returns 169 9 International Bond Risk Premia 171 9.1 Introduction 171 9.2 Literature Review 172 9.3 Notation and International Bond Market Data 174 9.3.1 Notation 174 9.3.2 International Bond Market Data 174 9.4 Unconditional Risk Premia 174 9.4.1 A Long-Term Perspective 174 9.4.2 More Recent Evidence 176 9.5 Conditional Risk Premia 177 9.5.1 Local Predictors of Returns 178 9.5.2 Global Predictors of Returns 182 9.6 Understanding Bond Risk Premia 185 9.6.1 Links to Economic Growth 185 9.6.2 State Dependency 187 9.7 Conclusion and Outlook 187 References 189 10 Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity 191 10.1 Introduction 191 10.2 Brief Literature Review 192 10.3 Bond Data and Definitions 193 10.3.1 Bond Notation and Definitions 193 10.3.2 Yield Data 194 10.4 Estimating the Liquidity Differential Between Inflation-Indexed and Nominal Bond Yields 194 10.4.1 Estimation Strategy 196 10.4.2 Data on Liquidity and Inflation Expectation Proxies 197 10.4.3 Estimating Differential Liquidity 197 10.5 Bond Excess Return Predictability 201 10.5.1 Economic Significance of Bond Risk Premia 205 10.6 Conclusion 206 References 208 11 U.S. Treasury Market: The High-Frequency Evidence 210 11.1 Introduction 210 11.2 The U.S. Treasury Markets During the Financial Crisis 211 11.2.1 Yields 211 11.2.2 Volatility 212 11.2.3 Off-the-Run/On-the-Run Yield Spread 213 11.2.4 Trading Volume and Price Impact 214 11.2.5 Fails 215 11.2.6 Intraday Evidence on March 18, 2009 215 11.2.7 Summary 216 11.3 The Reaction of Bond Prices and Interest Rates to Macroeconomic News 217 11.3.1 Level Effects 217 11.3.2 The Impact of Monetary Policy 218 11.3.3 Realized-Volatility Patterns 219 11.3.4 Macro News and Option-Implied Volatilities 220 11.3.5 ARCH and GARCH Effects 222 11.3.6 Jumps 224 11.3.7 Summary 227 11.4 Market-Microstructure Effects 228 11.4.1 Microstructure Effects in the Cash Market 228 11.4.2 Joint Microstructure Effects in the Cash Market and Futures Markets 231 11.4.3 Summary 232 11.5 Bond Risk Premia 232 11.5.1 Daily Evidence 232 11.5.2 Intraday Evidence 233 11.5.3 Summary 234 11.6 The Impact of High-Frequency Trading 234 11.6.1 The Effects of HFT on Liquidity, Volatility, and Risk Premia 234 11.6.2 Summary 236 11.7 Conclusions 236 References 236 Part V Advanced Topics on Term Structure Models and Their Estimation 239 12 Structural Affine Models for Yield Curve Modeling 241 12.1 Purpose and Structure of This Chapter 241 12.2 Structural Models 242 12.3 A Simple Taxonomy 242 12.4 Why do we Need No-Arbitrage Models After All? 243 12.5 Affine Models and the Drivers of The Yield Curve 244 12.5.1 Expectations 244 12.5.2 Term (Risk) Premia 244 12.5.3 Convexity 246 12.6 Introducing No-Arbitrage 247 12.7 Which Variables Should One use? 247 12.8 Risk Premia Implied by Affine Models with Constant Market Price of Risk 249 12.9 Testable Predictions: Constant Market Price of Risk 251 12.10 What Do We Know About Excess Returns? 251 12.11 Understanding the Empirical Results on term Premia 252 12.12 Enriching the First-Generation Affine Models 254 12.13 Latent Variables: The D'Amico, Kim, and Wei Model 254 12.14 From Linear Regressors to Affine Models: the ACM Approach 255 12.15 Affine Models using Principal Components as Factors 256 12.16 The Predictions from the "Modern" Models 258 12.17 Conclusions 261 12.17.1 Models as Enforcers of Parsimony and Builders of Confidence 261 12.17.2 Models as Enforcers of Cross-Sectional Restrictions 262 12.17.3 Models as Revealers of Forward-Looking Informations 262 12.17.4 Models as Enhancers of Understanding 262 References 263 13 The Econometrics of Fixed-Income Markets 265 13.1 Introduction 265 13.2 Different Types of Term Structure Models 266 13.2.1 Factor Models 266 13.2.2 Observable Factors 267 13.2.3 Latent Factors: Filtering versus Indirect Observation 267 13.2.4 Macroeconomic Models 267 13.2.5 Affine Models 268 13.2.6 Yield-Based Models 268 13.2.7 Forward-Based Models 269 13.3 Parametric Estimation Methods 269 13.3.1 GMM 270 13.3.2 Maximum Likelihood 270 13.3.3 QML 271 13.3.4 Efficient Method of Moments 271 13.3.5 Estimation Bias in Mean-Reversion Parameters 272 13.4 Maximum Likelihood Estimation 272 13.4.1 Observed State Variables 272 13.4.2 Latent State Variables 273 13.5 Constructing the Likelihood Function: Expansion of the Transition Density 275 13.5.1 Reducibility 276 13.5.2 The Irreducible Case 277 13.6 Concluding Remarks 278 References 279 14 Recent Advances in Old Fixed-Income Topics: Liquidity, Learning, and the Lower Bound 282 14.1 Introduction 282 14.2 Liquidity 283 14.2.1 Bills, Notes, and Bonds 283 14.2.2 Market Liquidity and Short-Selling Costs 284 14.2.3 Hedging Demand 286 14.2.4 Risky Arbitrage 287 14.2.5 Segmented Markets and Preferred Habitats 287 14.2.6 Funding Risk 288 14.2.7 Implication for Term Structure Models 290 14.3 Learning 291 14.3.1 Yield Survey Forecasts 292 14.3.2 Affine Term Structure Models 293 14.3.3 Spanning Survey Forecasts 297 14.3.4 Adaptive Learning and Survey Forecasts 299 14.3.5 Equilibrium Models of the Term Structure 300 14.4 Lower Bound 301 14.4.1 Square-Root and Autoregressive Gamma Models 301 14.4.2 Black (1995) – Tobin (1958) 303 14.4.3 No-Dominance Term Structure Models 305 14.4.4 Recent Empirical Results 306 14.5 Conclusion 309 14.6 Appendix: Moments of Truncated Bivariate Distribution 310 References 311 15 The Economics of the Comovement of Stocks and Bonds 313 15.1 Introduction 313 15.2 A Brief Literature Survey 313 15.3 The Stock–Bond Covariance and Learning about Fundamentals 315 15.3.1 Investors' Beliefs About Composite Regimes 316 15.3.2 Valuations and the "Fed Model" 316 15.3.3 Explaining the Time Variation in the Stock–Bond Covariance 318 15.4 Beliefs from Surveys and from the Model 319 15.5 Survey and Model Beliefs and the Stock–Bond Covariance 319 15.6 Some International Evidence 322 15.7 Summary 325 References 325 Part VI Derivatives: Markets and Pricing 327 16 Interest Rate Derivatives Products and Recent Market Activity in the New Regulatory Framework 329 16.1 Introduction 329 16.2 Background on the New Derivatives Regulatory Framework 331 16.2.1 Clearing 332 16.2.2 Execution 333 16.2.3 Reporting 333 16.3 Exchange-Traded Derivatives 335 16.3.1 Major Products 335 16.3.2 Execution 336 16.3.3 Clearing 336 16.3.4 Market Activity 339 16.4 Noncleared Swaps 341 16.4.1 Major Products 341 16.4.2 Execution 342 16.4.3 Credit Risk Mitigation 345 16.4.4 Market Activity 351 16.5 Cleared Swaps 354 16.5.1 Major Products 354 16.5.2 Market Activity 355 16.6 Comparative Market Activity Across Execution Venues 360 16.6.1 OTC versus Exchange-Traded Interest Rate Derivatives 360 16.6.2 Bilateral versus SEF Execution of OTC Interest Rate Derivatives 363 16.7 Liquidity Fragmentation in Nondollar Swaps 366 16.8 Prospects for the Future 368 16.8.1 Cleared Swaps and Exchange-Traded Interest Rate Derivatives 369 16.8.2 Swap Futures 370 16.8.3 Noncleared Swaps and End Users 370 16.9 Appendix: The New Regulatory Framework for Interest Rate Derivatives in the United States and European Union 371 16.9.1 Classifications of Market Participants 371 16.9.2 Clearing 373 16.9.3 Execution 375 16.9.4 Reporting 376 16.9.5 Margin Requirements for Noncleared Swaps 377 16.9.6 Capital Requirements for Noncleared Swaps 379 16.9.7 Cross-Border and Extraterritoriality Issues 381 References 385 17 Risk-Neutral Pricing: Trees 389 17.1 Introduction 389 17.2 Binomial Trees 389 17.2.1 One-Step Binomial Trees 389 17.2.2 The Market Price of Risk 393 17.3 Risk-Neutral Pricing on Multistep Trees 394 17.3.1 Calibration of Risk-Neutral Trees to the Yield Curve 395 17.3.2 The Pricing of European Options 397 17.3.3 The Pricing of American Options 400 17.4 From Diffusion Models to Binomial Trees 403 17.4.1 The Hull and White Model 405 17.5 Trinomial Trees 406 17.5.1 Calibration to the Yield Curve 407 17.5.2 Pricing Bermudan Contracts Using the Trinomial Tree 410 17.5.3 Calibration to the Volatility Curve 412 References 413 18 Discounting and Derivative Pricing Before and After the Financial Crisis: An Introduction 414 18.1 Introduction 414 18.2 Forward Rate Agreements (FRAs) 415 18.2.1 Forward Rates 417 18.2.2 Forward Rates after the Crisis 418 18.2.3 A Simple Explanation for the "Arbitrage" 420 18.3 Overnight Index Swaps (OISs) 422 18.3.1 OIS Discount Curve 424 18.4 LIBOR-Based Swaps 424 18.4.1 LIBOR Discount Curve with Single-Curve Pricing 426 18.5 The Crisis and the Double-Curve Pricing of LIBOR-Based Swaps 426 18.5.1 Extracting FRA Rates from Swap Quotes 428 18.5.2 Extracting the Discount Curve from FRA Rates 428 18.5.3 Summing Up 429 18.6 The Pricing of LIBOR-Based Interest Rate Options 430 18.6.1 Black's Option Pricing Formula 430 18.6.2 Caps and Floors before and after the Crisis 431 18.6.3 Swaptions before and after the Crisis 432 18.7 Conclusions 433 References 433 Part VII Advanced Topics in Derivatives Pricing 435 19 Risk-Neutral Pricing: Monte Carlo Simulations 437 19.1 Introduction 437 19.2 Risk-Neutral Pricing 437 19.2.1 Interest Rate Models 440 19.2.2 The Market Price of Risk 441 19.2.3 Valuation under P and under Q 441 19.2.4 Multifactor Models 442 19.3 Risk-Neutral Pricing: Monte Carlo Simulations 446 19.3.1 Discretization of the Vasicek Model 447 19.3.2 Discretization of the Cox–Ingersoll–Ross Model 448 19.3.3 Interest Rate Modeling at the Zero Lower Bound 451 19.4 Valuation by Monte Carlo Simulation 451 19.4.1 Valuation of Securities with Payoff at Fixed Date 452 19.4.2 mc Valuation of Callable Bonds 455 19.4.3 mc Valuation of Securities with American or Bermudan Exercise Style 456 19.5 Monte Carlo Simulations in Multifactor Models 461 19.5.1 Discretization Procedure of the Affine Factor Models 462 19.5.2 mc Simulations for Callable Securities in Multifactor Models 462 19.6 Conclusion 467 References 467 20 Interest Rate Derivatives and Volatility 469 20.1 Introduction 469 20.2 Markets and the Institutional Context 469 20.2.1 Market Size 469 20.2.2 OTC IRD Trading and Volatility 471 20.2.3 Exchange-Listed IRD Trading and Volatility 472 20.2.4 Recent Developments in the IRD Market 473 20.3 Dissecting the Instruments 473 20.3.1 Government Bonds 474 20.3.2 Time Deposits 476 20.3.3 Forwards Rate Agreements and Interest Rate Swaps 476 20.3.4 Caps, Floors, and Swaptions 478 20.4 Evaluation Paradigms 479 20.4.1 Models of the Short-term Rate 479 20.4.2 No-Arbitrage Models 481 20.4.3 Volatility 485 20.5 Pricing and Trading Volatility 487 20.5.1 Standard Volatility Trading Practice 488 20.5.2 An Introduction to Interest Rate Variance Swaps 489 20.5.3 Pricing Volatility in Three Markets 497 20.5.4 Current Forward-Looking Indexes of IRV 502 20.5.5 Products on IRV Indexes 505 20.6 Conclusions 507 20.7 Appendix 508 References 512 21 Nonlinear Valuation under Margining and Funding Costs with Residual Credit Risk: A Unified Approach 514 21.1 Introduction 514 21.2 Collateralized Credit and Funding Valuation Adjustments 516 21.2.1 Trading under Collateralization and Closeout Netting 517 21.2.2 Trading under Funding Risk 520 21.3 General Pricing Equation Under Credit, Collateral, and Funding 522 21.3.1 Discrete-Time Solution 523 21.3.2 Continuous-Time Solution 524 21.4 Numerical Results: Extending the Black–Scholes Analysis 527 21.4.1 Monte Carlo Algorithm 527 21.4.2 Market, Credit, and Funding Risk Specification 529 21.4.3 Preliminary Analysis without Credit Risk and with Symmetric Funding Rates 529 21.4.4 Full Analysis with Credit Risk, Collateral, and Funding Costs 531 21.4.5 Nonlinearity Valuation Adjustment 533 21.5 Extensions 535 21.6 Conclusions: Bilateral Prices or Nonlinear Values? 536 References 537 Part VIII Corporate and Sovereign Bonds 539 22 Corporate Bonds 541 22.1 Introduction 541 22.2 Market and Data 542 22.2.1 Data on Bond Characteristics 542 22.2.2 Data on Market Prices 542 22.2.3 Understanding Market Data from TRACE 543 22.3 A Very Simple Model 544 22.3.1 The Credit Spread Arising from Expected Loss 545 22.3.2 Adding a Risk Premium 545 22.4 Structural Models 546 22.4.1 Merton's Model with Beta 546 22.4.2 Bankruptcy Costs 549 22.4.3 Early Default 550 22.5 Reduced-form Models 550 22.5.1 A Useful Approximation 552 22.5.2 Closed-Form Solutions 553 22.6 Risk Premia in Intensity Models 554 22.7 Dealing with Portfolios 556 22.8 Illiquidity as a Source of Spreads 557 22.9 Some Additional Readings 558 22.10 Conclusion 559 References 559 23 Sovereign Credit Risk 561 23.1 Introduction 561 23.2 Literature Review 563 23.3 Modeling Sovereign Default 564 23.3.1 Risk-Neutral Pricing 564 23.3.2 Pricing Sovereign Credit Default Swaps 567 23.3.3 Pricing in a Lognormal Model 568 23.4 Credit Risk Premia 568 23.5 Estimating Intensity Models 569 23.6 Application to Emerging Markets 570 23.6.1 Credit Markets of Emerging Economies 571 23.6.2 Credit Risk Premia in Emerging Credit Markets 572 23.7 Application to the European Debt Crisis 575 23.7.1 Credit Risk Premia in the Eurozone 578 23.8 Conclusion 580 23.9 Appendix: No Arbitrage Pricing 580 23.9.1 The Risk-Neutral Default Intensity 583 References 584 Index 587

Long Description

Written by well-known experts from a cross section of academia and finance, Handbook of Fixed-Income Securities features a compilation of the most up-to-date fixed-income securities techniques and methods. The book presents crucial topics of fixed income in an accessible and logical format. Emphasizing empirical research and real-life applications, the book explores a wide range of topics from the risk and return of fixed-income investments, to the impact of monetary policy on interest rates, to the post-crisis new regulatory landscape. Well organized to cover critical topics in fixed income, Handbook of Fixed-Income Securities is divided into eight main sections that feature: An introduction to fixed-income markets such as Treasury bonds, inflation-protected securities, money markets, mortgage-backed securities, and the basic analytics that characterize them Monetary policy and fixed-income markets, which highlight the recent empirical evidence on the central banks influence on interest rates, including the recent quantitative easing experiments Interest rate risk measurement and management with a special focus on the most recent techniques and methodologies for asset-liability management under regulatory constraints The predictability of bond returns with a critical discussion of the empirical evidence on time-varying bond risk premia, both in the United States and abroad, and their sources, such as liquidity and volatility Advanced topics, with a focus on the most recent research on term structure models and econometrics, the dynamics of bond illiquidity, and the puzzling dynamics of stocks and bonds Derivatives markets, including a detailed discussion of the new regulatory landscape after the financial crisis and an introduction to no-arbitrage derivatives pricing Further topics on derivatives pricing that cover modern valuation techniques, such as Monte Carlo simulations, volatility surfaces, and no-arbitrage pricing with regulatory constraints Corporate and sovereign bonds with a detailed discussion of the tools required to analyze default risk, the relevant empirical evidence, and a special focus on the recent sovereign crises A complete reference for practitioners in the fields of finance, business, applied statistics, econometrics, and engineering, Handbook of Fixed-Income Securities is also a useful supplementary textbook for graduate and MBA-level courses on fixed-income securities, risk management, volatility, bonds, derivatives, and financial markets.

Details ISBN1118709195 Publisher John Wiley & Sons Inc Year 2016 ISBN-10 1118709195 ISBN-13 9781118709191 Format Hardcover Author Pietro Veronesi Media Book Short Title HANDBK OF FIXED-INCOME SECURIT Language English DEWEY 332.632 Edition 1st Place of Publication New York Country of Publication United States Edited by Pietro Veronesi Publication Date 2016-04-19 UK Release Date 2016-04-19 AU Release Date 2016-03-25 NZ Release Date 2016-03-25 Pages 640 Series Wiley Handbooks in Financial Engineering and Econometrics Imprint John Wiley & Sons Inc Audience Professional & Vocational US Release Date 2016-04-19 We've got this

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