Managing Model Risk: Part 1. “Models are Always Wrong”
“Models are always wrong,” said Joe Pimbley, Principal at Maxwell Consulting, via webinar on January 29, 2013. He was the first of a panel of three speakers invited by the Global Association of Risk Professionals to discuss model risk, what it is, and how to assess and validate it after the financial crisis. Models are always wrong, Pimbley clarified, because they are only simplifications. “Wrongness” he defined as some type of error or omission that materially impacts the results as understood by the user. A model can be wrong because the meaning of the result differs from that understood by […]
MATLAB for Excel Users: “Discoverability”
When looking for good data analysis tools, many financial professionals turn first to MS Excel which displays numeric data, contains advanced functions, and can be programmed with Visual Basic. A growing number of professionals are turning to MATLAB which has strengths complementary to ordinary spreadsheets. At a webinar on January 15, 2013, Adam Filion, application engineer at MathWorks, showed approximately three hundred audience members how easily features of MATLAB software adapt themselves to rapid analysis of large datasets. In Excel functions, the input is specified as a cell location and the math is hidden. In MATLAB, the interface has a […]
Analytical Tools to Gain Insight and Speed Up Numerical Analysis
“Symbolic computing can be a practical part of the solution to your problem,” said Deepak Ramaswamy, technical marketing manager at Mathworks. On January 8, 2013 he showed about three hundred participants via webinar how they could switch between analytical tools in a Notebook app to numerical analysis of the same problem in the MATLAB interface. He stepped his way through one “classic” and two “real-life” problems: the damped oscillator model; fuel consumption of a rocket-powered car; and kinematics of a double-jointed robot arm. The three problems can be written as systems of Ordinary Differential Equations (ODEs) and this was the […]
Libor Fallout: Part 3. A Muted Valuation Effect
On December 20, 2012, the third presenter at the GARP webinar on the LIBOR scandal was Robert Maxim, director of Complex Asset Solutions at Duff & Phelps. He spoke about the valuation implications of incorrect LIBOR rates. The cash flow of many financial instruments is indexed to LIBOR, he said, for big companies as well as small, and even for individual consumers such as those holding private student loans. Maxim considered an interest rate swap example in which the floating leg is tied to LIBOR. The valuation is always computed on the difference between the fixed and floating leg. “The […]
Libor Fallout: Part 2. Whistling Past the Graveyard
On December 20, 2012, the second presenter at the GARP webinar on the LIBOR scandal was Cliff Rossi, Executive-in-Residence, Center for Financial Policy, University of Maryland. He described the risk implications arising from the Wheatley Review of LIBOR. Rossi noted that some market participants were “still feeling PTSD from the financial crisis of 2008”—and then they got hit with the LIBOR scandal. Rossi succinctly described what went wrong: Low volume in interbank lending in unsecured transactions created an over-reliance on “expert judgement” hence the rate was subject to manipulation. Part of the problem, Rossi said, is that LIBOR reporting was […]
Libor Fallout: Part 1. The Stomach Ache During the Heart Attack
The emerging scandal around the setting of LIBOR (the London Interbank Offered Rate) prompted GARP (the Global Association of Risk Professionals) to convene a panel of three experts to inform its members about the background and implications of the LIBOR fraud. On December 20, 2012, the first presenter at the GARP webinar was Amy Poster, Strategic Adviser at Iron Harbor Capital Management. She described the background and key facts. Calling it the “$800 trillion scandal,” Poster said that these events touched many derivatives markets, various consumer debt instruments such as credit card loans, and 100 percent of the sub-prime market. […]
Mining Microeconomics Using MATLAB
Modelling the economics of an iron ore mine “is a complex task that can be made more reliable,” said David Willingham to a webinar audience on December 5, 2012. Willingham, an application engineer at Mathworks, was demonstrating how a typical mine’s economics could be modelled using MATLAB and then embedded within an Excel spreadsheet. Developing a mine involves significant capital expenditures and long time frames. Willingham aimed to take the audience through a good model that would take into account the microeconomics of a particular mining company, integrated with the macroeconomic environment, such as interest rates and iron ore prices. […]
Contingent Capital: The Case for COERCs. Part 2.
“Many people have misgivings about [contingent convertible bonds] because they just don’t know how to value them,” said George Pennacchi, Professor of Finance at University of Illinois. He was the second speaker at the November 29, 2012 GARP webinar on the subject of Call Option Enhanced Reverse Convertible (COERC) bonds. Click here to go to Part 1. Pennacchi, along with Theo Vermaelen and Christian Wolff, co-authored a recent paper proposing a new type of cocobond. [Contingent convertible bonds, or “cocobonds,” are bonds that convert into equity when the market value of capital falls below a trigger level.] “The paper provides a […]
Contingent Capital: The Case for COERCs. Part 1
Contingent convertible bonds, or “cocobonds,” are bonds that convert into equity when the market value of capital falls below a trigger level. A major problem with cocobonds is that “the conversion trigger is based on the capital ratio, which is known to be a poor indicator of financial distress,” said Theo Vermaelen, Professor of Finance at INSEAD. He was the first speaker at the November 29, 2012 webinar held by the Global Association of Risk Professionals (GARP) on the subject of Call Option Enhanced Reverse Convertible (COERC) bonds. Vermaelen referred to a case in point: a Credit Suisse cocobond issued […]
Develop & Deploy Financial Models
“Focus on modelling, not programming,” urged Ameya Deoras, senior applications engineer at MathWorks. He was speaking during a webinar on December 3, 2012 about the use of MATLAB in the construction of financial models. Deoras’ talk covered four examples to varying depth during the hour. The first example, the calculation of the efficient frontier for large-cap stocks, allowed him to show the easy data importation from an ODBC-compliant database. Each step of the way he showed how the input could be visualized with a single click. If the data exist in a relational database (think tables and fields such as […]