Impact of Negative Rates on Derivatives Valuations & Risk Calculations
A Case Study Focusing On Japan
The Bank of Japan recently adopted negative interest rates following the lead of several European central banks. Enacted to help stimulate their economies, these rates present big challenges to derivatives valuation and risk assessment in terms of curve construction, volatility quotation, volatility cube construction, and model calibration. Because assumptions as few as five years ago for many derivatives models didn’t allow for sub-zero rates, much of the industry has been left scrambling to adapt to the prolonged and increasingly negative rate environment.
Although there are several proposed approaches on the market to help alleviate the problems (from crude shifts to more flexible adaptations), the potential solutions can have quantitative effects on PnL and Greek calculations. These potential unknowns present challenges to banks who require a consistent modeling framework to properly capture negative rates and have accurate PnLs and risk assessment. And practitioners can’t help but wonder – how will my models react if rates continue to become even more negative?
On Wednesday, April 20th featured speaker Dr. Dan Li Senior Vice President and Global Head of Financial Engineering at Numerix presented a case study on the impact of negative rates for derivative practitioners. It was specifically focused on the Japanese derivative markets since the Bank of Japan pushed rates below zero. He delved into the current modeling challenges in dealing with these rates along with additional pricing and risk implications for financial institutions.
Dr. Li addressed the impact of negative interest rates on:
- Curve construction
- Volatility quotations
- Normal
- Shifted lognormal (displaced diffusion lognormal)
- Volatility interpolations
- Shifted SABR
- Free-boundary SABR
- Model calibration
- Valuations and risk sensitivities
Featured Speakers
Dan Li
Dan Li is a Vice President of Financial Engineering at Numerix in New York, in charge of Fixed Income (including Interest Rate, Cross Currency, Credit, Inflation, and Hybrid derivatives) and responsible for modeling, structuring, valuations and risk analytics.
Prior to Numerix, Mr. Li worked as a Quantitative Analyst on fixed income and equity trading desks in proprietary trading firms in Chicago and performed econometrics consulting in Texas. Mr. Li holds Masters degrees in both Computer Science and Economics/Finance from Texas A&M University and is currently a PhD candidate in Management Science/Finance at the Illinois Institute of Technology in Chicago.
As Chief Marketing Officer and Executive Vice President of Global Marketing & Corporate Communications, James leads the company’s global marketing and corporate communications efforts, spanning a diverse set of solutions and audiences. He oversees integrated marketing communications to clients in the largest global financial markets and to the Numerix partner network through the company's branding, electronic marketing, research, events, public relations, advertising and relationship marketing.
Since joining Numerix in 2008, James has launched the organization’s award-winning thought leadership program, bringing to light challenges and insights from Numerix market experts. He also hosts the Numerix Video Blog, tackling the challenges pressing the derivatives markets—from regulatory issues to trading strategies.
Prior to joining Numerix, James served as Managing Director of Global Marketing and Communications for Fitch Ratings. During his tenure at Fitch, he built the firm’s public relations program, oversaw investor relations and led marketing and communications plans for several acquisitions. Prior to Fitch, James was a member of the communications team at Moody's Investors Service.
