Riskless curve

I read this paper by Longstaff, Mithal and Neis (2004) in which they find the choice of the riskless curve has a big impact on determining the components of credit spreads. Academics typically use US Government Treasury securities as the benchmark riskless rate, however, Longstaff et al. (2004) use the swap curve instead. They find, in contrast to many previous studies, that default risk in fact explains most of the variation in spreads.

Now this is interesting as it casts doubt on previous results. It could potentially be that previous studies, using swaps rate instead of Treasury rates, might find that default risk is the major determinant instead.

The question is, why is the swap curve a better proxy for the riskless curve? Hull et al. (2004) provide an argument, but I am not thoroughly convinced (at least not intuitively clear) that is the case. They also mention that practitioners also use the swap curve as the benchmark.

New book

New book to be released in July 07:
How I Became a Quant: Insights from 25 of Wall Street's Elite

Credit spreads

I'm currently working on my dissertation on the credit spread puzzle. Basically, there is a wide gap between corporate bond yields and expected default losses, which imply that default risks can only explain a small proportion of the spread. This is commonly known as the credit spread puzzle.

Well, I've been reading several recent research papers to summarize what the answers to this puzzle could be. This isn't the difficult part, what is difficult is being able to criticize the papers, undermine their models and justify my arguments. In a theoretical dissertation, we're supposed to select 8-12 journal articles and present them. Firstly, these articles have a certain level of technical sophistication, and I am unable to completely comprehend the modelling details. How am I going to succinctly criticize the models or suggest ways to improve them? Secondly, my knowledge on credit risk is probably close to nothing, and it'll take a huge effort to produce something outstanding (yeah, I know I should have started a few months back). And lastly, I have only a week left to finish it...

Anyway, in case you're interested in this area, which is still a major current research theme, I can provide you with a good reference list that I've been collecting for some time. A good paper to look at is Hull, Predescu and White (2004), where they mention the possible answers as tax and liqudity factors, risk premium, traders' expectations, nondiversifiable risks and diversifiable risks.

AC413 Fixed Income Markets

This is an optional module that covers fixed income market organization, introduction to interest-rate products, pricing and calibration using tree methods, Ho-Lee model, securitization, credit risk.

Exam went well this morning, as expected since half units are supposed to be easier. My first internship assignment will be on FI research, so I hope what I learnt will be useful. I've found a website with very useful materials ranging from products introduced by IBs to internal research papers. I wonder how the guy managed to get hold of the soft copies.

Anyway, exams are over, just have to complete my dissertation by 18th June. Even if I get distinctions for all my modules, it will not be enough to condone the exam I failed on Tuesday. One exam has a big impact and I spoke to DC (a premier HH, if you're in the city you should know him) about my career plans. Though his words were encouraging, it still doesn't change the fact that I have failed in my goal of attaining a distinction. Which leaves me to ponder what exactly went wrong...how could I fail a module which I like so much (and I had a distinction for my mocks).

On a merrier note, I'll be celebrating end of exams with my coursemates tomorrow. A very much needed one. I ought to stay out and enjoy the sun more often.

More ABN Amro

Haven't really been keeping abreast with market news recently. Here are some articles on ABN Amro. Go read if you're interested (I'm actually more concerned about the plight of the employees than anything else).
uno
due
tre
quattro

AC436 Financial Economics

There's a reason why at the outset they said this is the hardest exam you'll ever take in your life. It's true. To squeeze discrete and continuous time finance into one course isn't easy, but the programme committee managed to do so. It isn't the best idea in the world, but I thought it's good that in a 10-month Masters you get to see different facets of the subject itself. However, my exam went bad, awful. Catastrophic. I'm certain I'm gonna fail this one.

I normally keep a cool head when it comes to stress, especially exam stress. Today I lost it, I was flimpsy. Racing against time, and with such a large stake on the table, I lost miserably. Everything went wrong, I couldn't even get the trivial things right. 6 hours spent on a cheat sheet that was never really used. The only positive I can take away is that almost everyone felt the same way.

I'll like to believe on any other day I'll be able to do much better. They say one bad day can change your life forever. Coming off a big setback last year, this one comes next. While you may think failing a module isn't a big deal, but it is...to me. My confidence has taken a large knock, and I need to sit down and rethink my career plans.

I'm sure I'm good at this subject, but my grades will be a counterfact. So much so for all those talk of being a quant. It's hard to swallow this, but I'll just take this as a bad day. Just disappointed at myself, really. I'm a slave of my own ambitions.

ps. sorry you have to bear this shit with me and listen to me whine and moan.

HJM

I need a better intuition of the HJM framework. I understand that it is different from equilibrium models in that it takes the entire forward curve as given to price interest-rate derivatives. But I'm not really sure of the implementation aspects, like how to incorporate randomness such that we get level and steepness effects. You can introduce two brownian motions to do that, but how?

I can embed simple equilibrium models into the HJM framework mechanically, i.e. following the steps in standard texts (which is just tedious calculus and algebra). But I can't really see how this is done in practice.

Exam is one day away. This is by far the most interesting module. Have been trying to solve the problem sets and I have to say I enjoy doing them. Various scenarious, various approaches. And everything boils down to the FTAP, and either using PDE or Feynman-Kac to solve. But it's those little tricks to begin with that eludes you. Will have a horrid time during the 3-hour exam. Not sure if I can finish all 4 problems.

Counting down

I'm already counting down the days to my internship, even though I'm not done with my finals. Have a rough idea of what the internship assessment is like, but only having 3 weeks at each desk renders you little time to learn much. Then of course there's a lot of networking involved, across desks and divisions. But I can't wait to get started, been eagerly planning for years to have a go at this.

I've been living in a cave for most of the last month or so, since everyone's too busy preparing for exams. Getting bored of this, going through lecture notes and problem sets over and over again...to the point I tell myself, fuck it, I don't need a distinction, just need to pass. Yesterday the weather was too tempting and I went down to the Tuns to catch England vs Brazil. It's good to see Beckham back.

Anyway, with only 3 days left to the hardest exam (Financial Economics), I'm beginning to feel restless. In the past, many people have failed this module, and I'm wondering what will happen to me if don't graduate this July. It's a real concern to all of us...we don't even want to book tickets for the graduation ceremony just yet. I should be worried, but I'm not? But all the martingale, markovian, diffusion, Ito, BS, EMM, HJM appear when I'm sleeping.

Aleksey Vayner

He became the city's headline grabber for a week sometime late last year. Whilst we were all busy doing job applications and getting stressed out as a result, this wanker-banker wannabe gave us something to talk about besides hardcore company research and FT market news. In case you missed his heroics, check this out.