Applications of Arbitrage-free Models New Frontiers in Interest Rate, Credit and Energy Risks

Applications of Arbitrage-free Models: New Frontiers in Interest Rate, Credit and Energy Risks Third Annual Bloomberg Lecture in Finance THOMAS S. Y. HO PhD PRESIDENT THC OCTOBER 26, 2009 [email protected]

Arbitrage-free Term Structure Models 2

Valuation models 

Derivative pricing (relative valuation) under interest rate, credit and other risk drivers

Applications   

Trading Portfolio management Enterprise risk management

Impacts on the markets  

Price discovery process Regulatory policies in the financial markets

Introduction

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Questions Addressed 3

What are the model’s economic principles that make

the model popular and fundamental? What are the frontiers of applications of the model in going forward? What are my cautionary notes on the use of the model? Detail discussions are available in the references

Introduction

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References 4 Amin,

Kaushik I., and Andrew J. Morton, 1994, “ Implied Volatility Functions in Arbitrage-free Term Structure Models, “ Journal of Financial Economics, 35 (2), 141-180 Benth, Fred Espen, Lars Ekeland, Ragner Hauger and Bjorn Fredrik Nielsen 2003 “A Note on Arbitrage-free Pricing of Forward Contracts in Energy Market” Applied Mathematical Finance 10, 325-336 Eydeland, Alexander and Krzysztof Wolyniec 2003 Energy and Power Risk Management, Wiley Finance Harrison, J Michael, and David M. Kreps, 1979 “Martingales and Arbitrage in Multiperiod Securities Markets