arXiv subjects

C. W. Oosterlee

Publications and source records attributed to C. W. Oosterlee.

9 recordsLinked to original sources

arXiv2025

Principal Component Copulas for Capital Modelling and Systemic Risk

We introduce a class of copulas that we call Principal Component Copulas (PCCs). This class combines the strong points of copula-based techniques with principal component analysis (PCA), which results in flexibility when modelling tail dependence along the most important directions in high-dimensional data. We obtain theoretical results for PCCs that are important for practical applications. In particular, we derive tractable expressions for the high-dimensional copula density, which can be represented in terms of characteristic functions. We also develop algorithms to perform Maximum Likelihood and Generalized Method of Moment estimation in high-dimensions and show very good performance in simulation experiments. Finally, we apply the copula to the international stock market to study systemic risk. We find that PCCs lead to excellent performance on measures of systemic risk due to their ability to distinguish between parallel and orthogonal movements in the global market, which have a different impact on systemic risk and diversification. As a result, we consider the PCC promising for capital models, which financial institutions use to protect themselves against systemic risk.

q-fin.RM↗

arXiv2024

Efficient Wrong-Way Risk Modelling for Funding Valuation Adjustments

Wrong-Way Risk (WWR) is an important component in Funding Valuation Adjustment (FVA) modelling. Yet, the standard assumption is independence between market risks and the counterparty defaults and funding costs. This typical industrial setting is our point of departure, where we aim to assess the impact of WWR without running a full Monte Carlo simulation with all credit and funding processes. We propose to split the exposure profile into two parts: an independent and a WWR-driven part. For the former, exposures can be re-used from the standard xVA calculation. We express the second part of the exposure profile in terms of the stochastic drivers and approximate these by a common Gaussian stochastic factor. Within the affine setting, the proposed approximation is generic, is an add-on to the existing xVA calculations and provides an efficient and robust way to include WWR in FVA modelling. Case studies for an interest rate swap and a representative multi-currency portfolio of swaps illustrate that the approximation method is applicable in a practical setting. We analyze the approximation error and use the approximation to compute WWR sensitivities, which are needed for risk management. The approach is equally applicable to other metrics such as Credit Valuation Adjustment.

q-fin.CP↗

arXiv2024

On the Hull-White model with volatility smile for Valuation Adjustments

Affine Diffusion dynamics are frequently used for Valuation Adjustments (xVA) calculations due to their analytic tractability. However, these models cannot capture the market-implied skew and smile, which are relevant when computing xVA metrics. Hence, additional degrees of freedom are required to capture these market features. In this paper, we address this through an SDE with state-dependent coefficients. The SDE is consistent with the convex combination of a finite number of different AD dynamics. We combine Hull-White one-factor models where one model parameter is varied. We use the Randomized AD (RAnD) technique to parameterize the combination of dynamics. We refer to our SDE with state-dependent coefficients and the RAnD parametrization of the original models as the rHW model. The rHW model allows for efficient semi-analytic calibration to European swaptions through the analytic tractability of the Hull-White dynamics. We use a regression-based Monte-Carlo simulation to calculate exposures. In this setting, we demonstrate the significant effect of skew and smile on exposures and xVAs of linear and early-exercise interest rate derivatives.

q-fin.CP↗

arXiv2023

Energy-stable discretization of the one-dimensional two-fluid model

In this paper we present a complete framework for the energy-stable simulation of stratified incompressible flow in channels, using the one-dimensional two-fluid model. Building on earlier energy-conserving work on the basic two-fluid model, our new framework includes diffusion, friction, and surface tension. We show that surface tension can be added in an energy-conserving manner, and that diffusion and friction have a strictly dissipative effect on the energy. We then propose spatial discretizations for these terms such that a semi-discrete model is obtained that has the same conservation properties as the continuous model. Additionally, we propose a new energy-stable advective flux scheme that is energy-conserving in smooth regions of the flow and strictly dissipative where sharp gradients appear. This is obtained by combining, using flux limiters, a previously developed energy-conserving advective flux with a novel first-order upwind scheme that is shown to be strictly dissipative. The complete framework, with diffusion, surface tension, and a bounded energy, is linearly stable to short wavelength perturbations, and exhibits nonlinear damping near shocks. The model yields smoothly converging numerical solutions, even under conditions for which the basic two-fluid model is ill-posed. With our explicit expressions for the dissipation rates, we are able to attribute the nonlinear damping to the different dissipation mechanisms, and compare their effects.

physics.flu-dyn↗

arXiv2022

Relevance of Wrong-Way Risk in Funding Valuation Adjustments

In March 2020, the world was thrown into financial distress. This manifested itself in increased uncertainty in the financial markets. Many interest rates collapsed, and funding spreads surged significantly, which increased due to the market turmoil. In light of these events, it is essential to understand and model Wrong-Way Risk (WWR) in a Funding Valuation Adjustment (FVA) context. WWR may currently be absent from FVA calculations in banks' Valuation Adjustment (xVA) engines. However, in this letter, we demonstrate that WWR effects are non-negligible in FVA modelling from a risk-management perspective. We look at the impact of various modelling choices, such as including the default times of the relevant parties, as well as stochastic and deterministic funding spreads. A case study is presented for interest rate derivatives.

q-fin.CP↗

arXiv2021

Energy-conserving formulation of the two-fluid model for incompressible two-phase flow in channels and pipes

We show that the one-dimensional (1D) two-fluid model (TFM) for stratified flow in channels and pipes (in its incompressible, isothermal form) satisfies an energy conservation equation, which arises naturally from the mass and momentum conservation equations that constitute the model. This result extends upon earlier work on the shallow water equations (SWE), with the important difference that we include non-conservative pressure terms in the analysis, and that we propose a formulation that holds for ducts with an arbitrary cross-sectional shape, with the 2D channel and circular pipe geometries as special cases. The second novel result of this work is the formulation of a finite volume scheme for the TFM that satisfies a discrete form of the continuous energy equation. This discretization is derived in a manner that runs parallel to the continuous analysis. Due to the non-conservative pressure terms it is essential to employ a staggered grid, which requires careful consideration in defining the discrete energy and energy fluxes, and the relations between them and the discrete model. Numerical simulations confirm that the discrete energy is conserved.

physics.flu-dyn↗

arXiv2020

Rule-based Strategies for Dynamic Life Cycle Investment

In this work, we consider rule-based investment strategies for managing a defined contribution saving scheme under the Dutch pension fund testing model. We found that dynamic rule-based investment can outperform traditional static strategies, by which we mean that the pensioner can achieve the target retirement income with higher probability and limit the shortfall when target is not met. In comparison with the popular dynamic programming technique, the rule-based strategy has a more stable asset allocation throughout time and avoid excessive transactions, which may be hard to explain to the investor. We also study a combined strategy of rule based target and dynamic programming in this work. Another key feature of this work is that there is no risk-free asset under our setting, instead, a matching portfolio is introduced for the investor to avoid unnecessary risk.

q-fin.PM↗

arXiv2020

A Computational Approach to Hedging Credit Valuation Adjustment in a Jump-Diffusion Setting

This study contributes to understanding Valuation Adjustments (xVA) by focussing on the dynamic hedging of Credit Valuation Adjustment (CVA), corresponding Profit & Loss (P&L) and the P&L explain. This is done in a Monte Carlo simulation setting, based on a theoretical hedging framework discussed in existing literature. We look at hedging CVA market risk for a portfolio with European options on a stock, first in a Black-Scholes setting, then in a Merton jump-diffusion setting. Furthermore, we analyze the trading business at a bank after including xVAs in pricing. We provide insights into the hedging of derivatives and their xVAs by analyzing and visualizing the cash-flows of a portfolio from a desk structure perspective. The case study shows that not charging CVA at trade inception results in an expected loss. Furthermore, hedging CVA market risk is crucial to end up with a stable trading strategy. In the Black-Scholes setting this can be done using the underlying stock, whereas in the Merton jump-diffusion setting we need to add extra options to the hedge portfolio to properly hedge the jump risk. In addition to the simulation, we derive analytical results that explain our observations from the numerical experiments. Understanding the hedging of CVA helps to deal with xVAs in a practical setting.

q-fin.CP↗

arXiv2014

Monte Carlo Calculation of Exposure Profiles and Greeks for Bermudan and Barrier Options under the Heston Hull-White Model

Valuation of Credit Valuation Adjustment (CVA) has become an important field as its calculation is required in Basel III, issued in 2010, in the wake of the credit crisis. Exposure, which is defined as the potential future loss of a default event without any recovery, is one of the key elementsfor pricing CVA. This paper provides a backward dynamics framework for assessing exposure profiles of European, Bermudan and barrier options under the Heston and Heston Hull-White asset dynamics. We discuss the potential of an efficient and adaptive Monte Carlo approach, the Stochastic Grid Bundling Method}(SGBM), which employs the techniques of simulation, regression and bundling. Greeks of the exposure profiles can be calculated in the same backward iteration with little extra effort. Assuming independence between default event and exposure profiles, we give examples of calculating exposure, CVA and Greeks for Bermudan and barrier options.

q-fin.CP↗