El objetivo de este trabajo es analizar la estabilidad de las calificaciones de riesgo crediticio (ratings) de un tipo de derivados de crédito conocido como synthetic Collateralized Debt Obligations (CDO sintéticos). Durante la crisis subprime gatillada el 2007, la mayoría de los derivados de crédito tipo CDO tuvo un muy mal desempeño. Debido a que cada CDO poseía una calificación de riesgo crediticio, este mal desempeño evidenció la falta de precisión de los ratings de las agencias calificadoras. En este contexto, este trabajo se enfoca en los CDO sintéticos, por dos motivos. Primero, pues ellos tuvieron un rol protagónico en la crisis subprime al transformarse en uno de los instrumentos favoritos de los especuladores para hacer “apuestas unidireccionales”. Y segundo, dado que los CDO sintéticos se transaban en un mercado secundario no regulado, y poco transparente, esto los hace más interesantes como objetos de estudio. Tradicionalmente, los ratings de las calificadoras de riesgo se han basado en un único estimador, sin considerar el error asociado con éste. Por ello, este trabajo analiza la estabilidad de las calificaciones de riesgo, mediante la estimación de intervalos de confianza y análisis de sensibilidad en función de los distintos parámetros considerados. Este trabajo utiliza la metodología de calificación de Moody’s, una de las calificadoras de mayor participación de mercado, que emplea el concepto de pérdida esperada. En el desarrollo de los análisis, se consideró la información a la cual un inversionista habría tenido acceso previo a la crisis subprime. Los casos de estudio seleccionados corresponden a CDO sintéticos representativos del mercado global de riesgo de crédito. Este trabajo concluye que el empleo de un solo valor como medida de riesgo de crédito para los CDO sintéticos es inadecuado. Los intervalos de confianza estimados para la perdida esperada contienen consistentemente más de un rating, es decir, contienen un margen de error significativo. Además, este trabajo revela que la información disponible previa a la crisis subprime habría permitido a inversionistas sofisticados haber detectado el peligroso margen de error asociado a los ratings. Por último, este trabajo pone de manifiesto la importancia de reconsiderar la estructura de los marcos regulatorios financieros que en la mayoría de los países se basan en ratings emitidos por calificadoras de riesgo, y por lo tanto, son inherentemente inestables. Considerando la importancia de las conclusiones de este trabajo, sería interesante extender esta investigación a otras metodologías de calificación de riesgo y a otros tipos de derivados de crédito.

Master of Science / Department of Industrial & Manufacturing Systems Engineering / Chih-Hang Wu / The recent economic crisis has been partially blamed on the decline in the housing market. This decline in the housing market resulted in an estimated 87% decline in value of collateralized debt obligations (CDOs) between 2007 and 2008. This drastic decline in home values was sudden and unanticipated, thus it was incomprehensible for many investors how this would affect CDOs. This shows that while analytical techniques can be used to price CDOs, these techniques cannot be used to demonstrate the behavior of CDOs under radically different economic circumstances. To better understand the behavior of CDOs under different economic circumstances, numerical techniques such as Monte Carlo simulation can be used instead of analytical techniques to price CDOs. Andersen et al (2005) proposed a method for calculating the probability of defaults that could then be used in the Monte Carlo simulation to price the collateralized debt obligation. The research proposed by Andersen et al (2005) demonstrates the process of calculating correlated probability of defaults for a group of obligors. This calculation is based on the correlations between the obligors using copulas. Using this probability of default, the price of a collateralized debt obligation can be evaluated using Monte Carlo simulation. Monte Carlo simulation provides a more simple yet effective approach compared to analytical pricing techniques. Simulation also allows investors to have a better understanding of the behaviors of CDOs compared to analytical pricing techniques. By analyzing the various behaviors under uncertainty, it can be observed how a downturn in the economy could affect CDOs. This thesis extends on the use of copulas to simulate the correlation between obligors. Copulas allow for the creation of one joint distribution using a set of independent distributions thus allowing for an efficient way of modeling the correlation between obligors. The research contained within this thesis demonstrates how Monte Carlo simulation can be used to effectively price collateralized debt obligations. It also shows how the use of copulas can be used to accurately characterize the correlation between obligor defaults for pricing collateralized debt obligations. Numerical examples for both the obligor defaults and the price of collateralized debt obligations are presented to demonstrate the results using Monte Carlo simulation.

I re-examine “rating shopping” and “rating catering” in the market for AAA rated collateralized debt obligations (CDOs) by replicating the study of Griffin and Tang (2013) using post-crisis data. I find a sharp increase in the amount of CDOs that received a single rating, suggesting that CDO underwriters were more cautious about formally soliciting multiple ratings. However, I also find a decrease in AAA rating disagreements between S&P and Moody’s, implying that issuers shopped their CDOs through informal conversations with agencies. Finally, I find investors correctly accepted tighter credit spreads for dual-rated CDOs because dual-rated CDOs experienced fewer rating downgrades than single rated deals. These results differ from the pre-crisis findings of Griffin and Tang (2013) and are consistent with the existence of rating shopping and disappearance of rating catering during the post-crisis period.

A credit default swap is a contract that ensures protection against losses occurring due to a default event of an certain entity. It is crucial to know how default should be modelled for valuation or estimating of credit derivatives. In this dissertation, we first review the structural approach for modelling credit risk. The model is an approach for assessing the credit risk of a firm by typifying the firms equity as a European call option on its assets, with the strike price (or exercise price) being the promised debt repayment at the maturity. The model can be used to determine the probability that the firm will default (default probability) and the Credit Spread. We second concentrate on the valuation of credit derivatives, in particular the Credit Default Swap (CDS) when the hazard rate (or even of default) is modelled as the Vasicek-type model. The other objective is, by using South African credit spread data on defaultable bonds to estimate parameters on CIR and Vasicek-type Hazard rate models such as stochastic differential equation models of term structure. The parameters are estimated numerically by the Moment Method. / Thesis (M.Sc.)-University of KwaZulu-Natal, Durban, 2013.

Incomplete markets provide many challenges for both investment decisions and valuation problems. While both problems have received extensive attention in complete markets, there remain many open areas in the theory of incomplete markets. We present the results in three parts. In the first essay we consider the Merton investment problem of optimal portfolio choice when the traded instruments are the set of zero-coupon bonds. Working within a Markovian Heath-Jarrow-Morton framework of the interest rate term structure driven by an infinite dimensional Wiener process, we give sufficient conditions for the existence and uniqueness of an optimal investment strategy. When there is uniqueness, we provide a characterization of the optimal portfolio. Furthermore, we show that a specific Gauss-Markov random field model can be treated within this framework, and explicitly calculate the optimal portfolio. We show that the optimal portfolio in this case can be identified with the discontinuities of a certain function of the market parameters. In the second essay we price a claim, using the indifference valuation methodology, in the model presented in the first section. We appeal to the indifference pricing framework instead of the classic Black-Scholes method due to the natural incompleteness in such a market model. Because we price time-sensitive interest rate claims, the units in which we price are very important. This will require us to take care in formulating the investor’s utility function in terms of the units in which we express the wealth function. This leads to new results, namely a general change-of-numeraire theorem in incomplete markets via indifference pricing. Lastly, in the third essay, we propose a method to price credit derivatives, namely collateralized debt obligations (CDOs) using indifference. We develop a numerical algorithm for pricing such CDOs. The high illiquidity of the CDO market coupled with the allowance of default in the underlying traded assets creates a very incomplete market. We explain the market-observed prices of such credit derivatives via the risk aversion of investors. In addition to a general algorithm, several approximation schemes are proposed. / text

University, Diss--Köln, 2005.

Due to the apparent global economic conditions, at the end of 2008, the International Accounting Standards Board (IASB) issued amendments to IAS 39 Financial instruments: recognition and measurement and IFRS 7 Financial instruments: disclosures in October and November, 2008. The amendments allow banks to reclassify their non-derivative financial instruments in rare circumstances. This thesis investigates whether banks in the Nordic countries (Denmark, Finland, Norway, and Sweden) reclassify financial instruments, in their financial statements of 2008 and 2009. The result of the study shows that 47% of the sample Nordic banks reclassified financial instruments in 2008 and 12% in 2009. All banks increased their net profit as a result of reclassifying financial instruments in 2008. The return on equity (ROE) increased significantly compared to whether the banks would not had reclassified their financial instruments. Tendencies found among the sample Nordic banks are that larger and less profitable banks used the possibility to reclassify financial instruments to a greater extent. Because none of the banks made losses on their choice to reclassify in 2008, the conclusion is that the opportunity given due to the amendments are mostly used by the banks to enhance the net income and the key ratio ROE. This shows that management decisions are short-term. This also indicates that the amendments may be misused by management to enhance current profit for their own benefit. The thesis also concludes that the departure from fair-value as the valuation method for financial instruments, due to recent massive critic, is unlikely.

<p>Due to the apparent global economic conditions, at the end of 2008, the International Accounting Standards Board (IASB) issued amendments to IAS 39 <em>Financial instruments: recognition and measurement </em>and IFRS 7 <em>Financial instruments: disclosures</em> in October and November, 2008. The amendments allow banks to reclassify their non-derivative financial instruments in rare circumstances. This thesis investigates whether banks in the Nordic countries (Denmark, Finland, Norway, and Sweden) reclassify financial instruments, in their financial statements of 2008 and 2009.</p><p>The result of the study shows that 47% of the sample Nordic banks reclassified financial instruments in 2008 and 12% in 2009. All banks increased their net profit as a result of reclassifying financial instruments in 2008. The return on equity (ROE) increased significantly compared to whether the banks would not had reclassified their financial instruments. Tendencies found among the sample Nordic banks are that larger and less profitable banks used the possibility to reclassify financial instruments to a greater extent. Because none of the banks made losses on their choice to reclassify in 2008, the conclusion is that the opportunity given due to the amendments are mostly used by the banks to enhance the net income and the key ratio ROE. This shows that management decisions are short-term. This also indicates that the amendments may be misused by management to enhance current profit for their own benefit. The thesis also concludes that the departure from fair-value as the valuation method for financial instruments, due to recent massive critic, is unlikely.</p>

Many analysts believe that problems in the U.S. housing market initiated the 2008–2010 global financial crisis. In this regard, the subprime mortgage crisis (SMC) shook the foundations of the financial industry by causing the failure of many iconic Wall Street investment banks and prominent depository institutions. This crisis stymied credit extension to households and businesses thus creating credit crunches and, ultimately, a global recession. This thesis specifically discusses the SMC and its components, causes, consequences and cures in relation to subprime mortgages, securitization, as well as data. In particular, the SMC has highlighted the fact that risk, credit ratings, profit and valuation as well as capital regulation are important banking considerations. With regard to risk, the thesis discusses credit (including counterparty), market (including interest rate, basis, prepayment, liquidity and price), tranching (including maturity mismatch and synthetic), operational (including house appraisal, valuation and compensation) and systemic (including maturity transformation) risks. The thesis introduces the IDIOM hypothesis that postulates that the SMC was largely caused by the intricacy and design of subprime agents, mortgage origination and securitization that led to information problems (loss, asymmetry and contagion), valuation opaqueness and ineffective risk mitigation. It also contains appropriate examples, discussions, timelines as well as appendices about the main results on the aforementioned topics. Numerous references point to the material not covered in the thesis, and indicate some avenues for further research. In the thesis, the primary subprime agents that we consider are house appraisers (HAs), mortgage brokers (MBs), mortgagors (MRs), servicers (SRs), SOR mortgage insurers (SOMIs), trustees, underwriters, credit rating agencies (CRAs), credit enhancement providers (CEPs) and monoline insurers (MLIs). Furthermore, the banks that we study are subprime interbank lenders (SILs), subprime originators (SORs), subprime dealer banks (SDBs) and their special purpose vehicles (SPVs) such as Wall Street investment banks and their special structures as well as subprime investing banks (SIBs). The main components of the SMC are MRs, the housing market, SDBs/hedge funds/money market funds/SIBs, the economy as well as the government (G) and central banks. Here, G either plays a regulatory or policymaking role. Most of the aforementioned agents and banks are assumed to be risk neutral with SOR being the exception since it can be risk (and regret) averse on occasion. The main aspects of the SMC - subprime mortgages, securitization, as well as data - that we cover in this thesis and the chapters in which they are found are outlined below. In Chapter 2, we discuss the dynamics of subprime SORs' risk and profit as well as their valuation under mortgage origination. In particular, we model subprime mortgages that are able to fully amortize, voluntarily prepay or default and construct a discrete–time model for SOR risk and profit incorporating costs of funds and mortgage insurance as well as mortgage losses. In addition, we show how high loan–to–value ratios due to declining housing prices curtailed the refinancing of subprime mortgages, while low ratios imply favorable house equity for subprime MRs. Chapter 3 investigates the securitization of subprime mortgages into structured mortgage products such as subprime residential mortgage–backed securities (RMBSs) and collateralized debt obligations (CDOs). In this regard, our discussions focus on information, risk and valuation as well as the role of capital under RMBSs and RMBS CDOs. Our research supports the view that incentives to monitor mortgages has been all but removed when changing from a traditional mortgage model to a subprime mortgage model. In the latter context, we provide formulas for IB's profit and valuation under RMBSs and RMBS CDOs. This is illustrated via several examples. Chapter 3 also explores the relationship between mortgage securitization and capital under Basel regulation and the SMC. This involves studying bank credit and capital under the Basel II paradigm where risk–weights vary. Further issues dealt with are the quantity and pricing of RMBSs, RMBS CDOs as well as capital under Basel regulation. Furthermore, we investigate subprime RMBSs and their rates with slack and holding constraints. Also, we examine the effect of SMC–induced credit rating shocks in future periods on subprime RMBSs and RMBS payout rates. A key problem is whether Basel capital regulation exacerbated the SMC. Very importantly, the thesis answers this question in the affirmative. Chapter 4 explores issues related to subprime data. In particular, we present mortgage and securitization level data and forge connections with the results presented in Chapters 2 and 3. The work presented in this thesis is based on 2 peer–reviewed chapters in books (see [99] and [104]), 2 peer–reviewed international journal articles (see [48] and [101]), and 2 peer–reviewed conference proceeding papers (see [102] and [103]). / Thesis (Ph.D. (Applied Mathematics))--North-West University, Potchefstroom Campus, 2011.

Many analysts believe that problems in the U.S. housing market initiated the 2008–2010 global financial crisis. In this regard, the subprime mortgage crisis (SMC) shook the foundations of the financial industry by causing the failure of many iconic Wall Street investment banks and prominent depository institutions. This crisis stymied credit extension to households and businesses thus creating credit crunches and, ultimately, a global recession. This thesis specifically discusses the SMC and its components, causes, consequences and cures in relation to subprime mortgages, securitization, as well as data. In particular, the SMC has highlighted the fact that risk, credit ratings, profit and valuation as well as capital regulation are important banking considerations. With regard to risk, the thesis discusses credit (including counterparty), market (including interest rate, basis, prepayment, liquidity and price), tranching (including maturity mismatch and synthetic), operational (including house appraisal, valuation and compensation) and systemic (including maturity transformation) risks. The thesis introduces the IDIOM hypothesis that postulates that the SMC was largely caused by the intricacy and design of subprime agents, mortgage origination and securitization that led to information problems (loss, asymmetry and contagion), valuation opaqueness and ineffective risk mitigation. It also contains appropriate examples, discussions, timelines as well as appendices about the main results on the aforementioned topics. Numerous references point to the material not covered in the thesis, and indicate some avenues for further research. In the thesis, the primary subprime agents that we consider are house appraisers (HAs), mortgage brokers (MBs), mortgagors (MRs), servicers (SRs), SOR mortgage insurers (SOMIs), trustees, underwriters, credit rating agencies (CRAs), credit enhancement providers (CEPs) and monoline insurers (MLIs). Furthermore, the banks that we study are subprime interbank lenders (SILs), subprime originators (SORs), subprime dealer banks (SDBs) and their special purpose vehicles (SPVs) such as Wall Street investment banks and their special structures as well as subprime investing banks (SIBs). The main components of the SMC are MRs, the housing market, SDBs/hedge funds/money market funds/SIBs, the economy as well as the government (G) and central banks. Here, G either plays a regulatory or policymaking role. Most of the aforementioned agents and banks are assumed to be risk neutral with SOR being the exception since it can be risk (and regret) averse on occasion. The main aspects of the SMC - subprime mortgages, securitization, as well as data - that we cover in this thesis and the chapters in which they are found are outlined below. In Chapter 2, we discuss the dynamics of subprime SORs' risk and profit as well as their valuation under mortgage origination. In particular, we model subprime mortgages that are able to fully amortize, voluntarily prepay or default and construct a discrete–time model for SOR risk and profit incorporating costs of funds and mortgage insurance as well as mortgage losses. In addition, we show how high loan–to–value ratios due to declining housing prices curtailed the refinancing of subprime mortgages, while low ratios imply favorable house equity for subprime MRs. Chapter 3 investigates the securitization of subprime mortgages into structured mortgage products such as subprime residential mortgage–backed securities (RMBSs) and collateralized debt obligations (CDOs). In this regard, our discussions focus on information, risk and valuation as well as the role of capital under RMBSs and RMBS CDOs. Our research supports the view that incentives to monitor mortgages has been all but removed when changing from a traditional mortgage model to a subprime mortgage model. In the latter context, we provide formulas for IB's profit and valuation under RMBSs and RMBS CDOs. This is illustrated via several examples. Chapter 3 also explores the relationship between mortgage securitization and capital under Basel regulation and the SMC. This involves studying bank credit and capital under the Basel II paradigm where risk–weights vary. Further issues dealt with are the quantity and pricing of RMBSs, RMBS CDOs as well as capital under Basel regulation. Furthermore, we investigate subprime RMBSs and their rates with slack and holding constraints. Also, we examine the effect of SMC–induced credit rating shocks in future periods on subprime RMBSs and RMBS payout rates. A key problem is whether Basel capital regulation exacerbated the SMC. Very importantly, the thesis answers this question in the affirmative. Chapter 4 explores issues related to subprime data. In particular, we present mortgage and securitization level data and forge connections with the results presented in Chapters 2 and 3. The work presented in this thesis is based on 2 peer–reviewed chapters in books (see [99] and [104]), 2 peer–reviewed international journal articles (see [48] and [101]), and 2 peer–reviewed conference proceeding papers (see [102] and [103]). / Thesis (Ph.D. (Applied Mathematics))--North-West University, Potchefstroom Campus, 2011.