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SESSION V-2 : INTEREST RATES (19/12/2008 à 08h30)

Impacts of Jumps and Stochastic Interest Rates on the Fair Costs of Guaranteed Minimum Death Benefit Contracts

Auteurs : QUITTARD-PINON François (EM Lyon Business School); RANDRIANARIVONY Rivo (Université de Lyon)

Intervenants : RANDRIANARIVONY Rivo (Université de Lyon)

The authors offer a new perspective to the domain of guaranteed minimum death benefit contracts. These products have the particular feature to offer investors a guaranteed capital upon death. A complete methodology based on the generalized Fourier transform is proposed to investigate the impacts of jumps and stochastic interest rates. This paper thus extends Milevsky and Posner (2001). In contrast to their results, the fair costs of the guarantee feature are found to be substantially higher in this more general economy.

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Rating Migrations: the Effect of History and Time

Auteurs : DANG Huong; PARTINGTON Graham (University of Sydney)

Intervenants : DANG Huong (University of Sydney)

We use the Cox proportional hazard model to investigate the probability of rating transitions using data for the period 1986 to 2005. Variables that capture rating history and the current rating significantly affect the probability of a rating transition. Different models are required for upgrades and downgrades, but the evidence consistently shows a tendency for history to repeat itself. Longer lagged durations in ratings tend to lead to longer subsequent durations and rating changes exhibit momentum. In addition to lagged duration and the direction of the lagged rating change, other significant variables are the rate of prior rating changes, the firm’s first ever rating, the time elapsed since that first rating, and having a period of being unrated. There is also evidence of interactions between the time spent in a rating grade and the main effect variables. The extent of these time interactions is greater for downgrades than for upgrades. The nature of the interaction is that the impact of the rating history variables diminishes as the time spent in the current rating gets bigger. The time interaction for the current rating diminishes the impact of the current rating for downgrades and intensifies it for upgrades.

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The Immunization Performance of Traditional and Stochastic Durations: A Mean-Variance Analysis

Auteurs : FRANCOIS Pascal (HEC Montréal); MORAUX Franck (Université de Rennes 1)

Intervenants : MORAUX Franck (Université de Rennes 1)

This paper provides a mean-variance analysis of immunization strategies that trade off coupon reinvestment risk with resale price risk. For static immunization strategies, neither traditional nor stochastic durations fall in the set of efficient horizons. This finding is robust across various interest rate environments and bond characteristics, and explains the poor immunization results obtained by the comparative study of Gultekin and Rogalski (1984). When dynamic portfolio rebalancing is allowed, traditional and stochastic durations induce efficient strategies with similar performance. We therefore obtain that immunization performance is more driven by strategy sophistication rather than by the choice of duration, which corroborates the empirical finding of Agca (2005). Our results still hold under the two-factor term structure model with stochastic volatility of Longstaff and Schwartz (1992).

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Representative Yield Curve Shocks and Stress Testing

Auteurs : DIEBOLD Francis(University of Pennsylvania);LI Canlin(University of California);PERIGNON Christophe(HEC Paris);VILLA Christophe

Intervenants : VILLA Christophe (Audencia School of Management)

In this paper we propose a systematic procedure to identify a set of representative yield curve shocks and use them for stress-testing purposes. We first fit a factor model to actual bond yields and estimate the main shape factors of the yield curve. We then partition the factors into non-overlapping sets of representative shocks. The key feature of our procedure is that it provides a wide variety of yield curve shocks including typical, uncommon, and extreme ones. We apply our methodology to a variety of bond strategies using actual U.S. yields.

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