Interest rate and credit risk models

Summary

This course gives an introduction to the modeling of interest rates and credit risk. Such models are used for the valuation of interest rate securities with and without credit risk, the management and hedging of bond portfolios and the valuation and usage of interest rate and credit derivatives.

Content

Keywords

interest rate risk, credit risk, term structure, bonds, interest rate swaps, caps and floors, short rate models, HJM models, bankruptcy, ratings, CDS, structural models, reduced-form models

Learning Prerequisites

Required courses

• Probability and stochastic calculus
• Derivatives
• Econometrics
• Introduction to finance

Learning Outcomes

By the end of the course, the student must be able to:

• Describe the various notions of interest rates and related basic products
• Apply the basic tools duration and convexity for interest rate risk management
• Derive an estimated term structure from market data
• Reconstruct the implied volatility surface for caps, floors, and swaptions from market data
• Implement some basic stochastic interest rate models, including the Vasicek and CIR short rate models
• Apply the industry standard Black and Bachelier models for pricing and quoting caps, floors, and swaptions
• Differentiate between structural and reduced-form models
• Assess / Evaluate Credit Default Swaps (CDS)

Transversal skills

• Use a work methodology appropriate to the task.

Teaching methods

Lectures, exercises, homework

Expected student activities

active attendance at lectures, completing exercises

Assessment methods

• 40% midterm exam
• 60% final exam

Resources

Bibliography

L. Andersen and V. Piterbarg, Interest Rate Modeling, Atlantic Financial Press, 2010.

D. Brigo and F. Mercurio, Interest rate models: Theory and practice, 2nd Edition, Springer Verlag, New York, 2007.

D. Filipovic, Term-Structure Models, Springer Verlag, 2009.

D. Lando, Credit Risk Modeling: Theory and Applications, Princeton University Press, 2004.

A. McNeil, R. Frey, P. Embrechts, Quantitative Risk Management, Princeton University Press, 2015.

Ressources en bibliothèque

• Quantitative Risk Management / McNeil
• Interest Rate Modeling / Andersen
• Term-Structure Models / Filipovic
• Credit Risk Modeling: Theory and Applications / Lando
• Interest rate models: Theory and practice / Brigo

Moodle Link

• https://go.epfl.ch/FIN-416