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Assessment of model risk through hedging simulations: valuation of Bermudan swaptions with a one-factor Hull-White model

Nikolopoulos, Panayiotis A. (2010) Assessment of model risk through hedging simulations: valuation of Bermudan swaptions with a one-factor Hull-White model.

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Abstract:In times of globalized �nancial markets, where the complexity of derivative contracts is severely increasing, the use of advanced models for pricing and hedging is required. Under this situation, the �nancial institutions desire to quantify the risk and the P&L of their trading portfolios. Part of these portfolios consists of contracts with model dependent values. The models for pricing and risk management are used as an imitation of the actual market evolution and they are based on various assumptions. The risk management practice considers as a key factor the quanti�cation of the risk due to the use of a particular model. This motivates us to investigate the model risk of a popular model within the interest rate markets, namely the Hull and White short rate model. In this project we will show how the calibrated Hull and White model affects the hedging outcomes of discrete replicating strategies on Bermudan swaptions. Our analysis will allow drawing several conclusions upon the behavior of the model under mean reversion uncertainty. Finally, we are able to give an estimate of mean reversion risk using an alternative approach of measurement based on the risk level of the derivative contract.
Item Type:Essay (Master)
Clients:
ING Group, CMRM Quants Team
Faculty:EEMCS: Electrical Engineering, Mathematics and Computer Science
Subject:31 mathematics
Programme:Applied Mathematics MSc (60348)
Link to this item:http://purl.utwente.nl/essays/61747
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