In a previous post entitled Credit Risk Management Using Merton Model we provided a brief theoretical description of the Merton structural credit risk model. Note that, The Merton model is an analysis model – named after economist Robert C. Merton – used to assess the credit risk of a company’s …

An interest rate swap (IRS) is a financial derivative instrument that involves an exchange of a fixed interest rate for a floating interest rate.  More specifically, An interest rate swap’s (IRS’s) effective description is a derivative contract, agreed between two counterparties, which specifies the nature of an exchange of payments …

In a previous post, we provided an example of pricing American options using an analytical approximation. Such a pricing model is fast and accurate enough for risk management purposes. However, sometimes more accurate results are required. For this purpose, the binomial (lattice) model can be used. Wikipedia describes the binomial …

R. Merton published a seminal paper that laid the foundation for the development of structural credit risk models. In this post, we’re going to provide an example of how it can be used for managing credit risks. Within the Merton model, equity of a firm is considered a call …

In the previous installment, we presented a concrete example of pricing a European option. In this follow-up post we are going to provide an example of valuing American options. The key difference between American and European options relates to when the options can be exercised: A European option may be …

An option is a financial contract that gives you a right, but not an obligation to buy or sell an underlying at a future time and at a pre-determined price.  Specifically, …  an option is a contract which gives the buyer (the owner or holder of the option) the right, …

Last year, in a post entitled Credit Derivatives-Is This Time Different we wrote about credit derivatives and their potential impact on the markets. Since then, they have started attracting more and more attention. For example, Bloomberg recently reported that collateralized loan obligations (CLO), a type of complex credit derivatives, are …

The overnight index swap (OIS) has come into the spotlight recently, due to the widening of the Libor-OIS spread. For example, the Economist recently reported: WATCHING financial markets can be like watching a horror film. A character walks into the darkness alone. A floorboard creaks. The latest spooky sign is …

We have written many blog posts about the increase in volatility of volatility. See, for example Is Volatility of Volatility Increasing? What Caused the Increase in Volatility of Volatility? Similarly, last week Bloomberg reported, The sudden rise in volatility in February and March showed that even with strong growth fundamentals, …

The US equity market just reached new highs, and it broke many records.  For example, Bloomberg reported that the US market had not been overbought like this in 21 years. The S&P 500 Index’s superlative start to 2018 is making a contrarian technical indicator look silly. The benchmark gauge is …