System and methods for valuing and managing the risk of credit instrument portfolios

• US 7,526,446 B2
• Filed: 01/17/2002
• Issued: 04/28/2009
• Est. Priority Date: 01/10/2002
• Status: Expired due to Fees

• Current Assignee: International Business Machines Corporation
• Original Assignee: Algorithmics International Corporation
• Inventors: Rosen, Dan, Kreinin, Alexander, Forest, Lawrence R. Jr., Aguais, Scott, Farber, Victoria, Suchower, Steve, Belkin, Barry
• Primary Examiner(s): Poinvil; Frantzy
• Assistant Examiner(s): GRAHAM, CLEMENT B
• Application Number:
  US10/051,905
• Publication Number:
  US 20030135450A1
• Time in Patent Office: 2,658 Days
• Field of Search: 705 35- 38, 705/40
• US Class Current: 705/38
• CPC Class Codes: G06Q 40/00 Finance; Insurance; Tax strategies; Processing of corporate or income taxes
• CPC Class Codes: G06Q 40/03 Credit; Loans; Processing thereof
• CPC Class Codes: G06Q 40/04 Trading; Exchange, e.g. stocks, commodities, derivatives or currency exchange
• CPC Class Codes: G06Q 40/08 Insurance

Abstract

The present invention relates generally to a system of components, comprising an integrated architecture, which supports calibration of financial models, and the structuring, pricing, mark-to-market valuation, simulation, risk management, and reporting of a variety of credit instruments subject to both credit and market risk (e.g., interest rate, foreign exchange risk). Detailed instrument complexities may be accommodated, by modeling the underlying economic behavior driving the exercise of embedded options and other structural features of credit instruments by implementing detailed economic behavioral models. In one aspect of the present invention, the system comprises a database for storing credit instrument data, a first calibration engine for generating calibration parameters from the credit instrument data, a second pricing engine adapted to calculate the net present values and valuation metrics for the credit instruments by modeling the underlying economic behavior driving the exercise of embedded options and other structural features of the credit instruments, a third engine for performing simulation-based computations, a fourth risk engine for computing risk and reward metrics, and a report generator for generating reports for use in managing risk.

Claims

1. A no-arbitrage-based system for valuing one or more credit instruments, said system comprising:

a) a database having a machine readable storage medium for storing credit instrument data;

b) a first calibration engine connected to said database, wherein said first calibration engine generates calibration parameters from said credit instrument data and current market data, said credit instrument data comprising market data;

C) a second pricing engine connected to said database and said first calibration engine, wherein said second pricing engine is configured to use said calibration parameters to value said one or more credit instruments according to no-arbitrage financial principles, wherein at least one of a net present value and a par-spread is calculated for each of said one or more credit instruments using current market data;

d) a third engine connected to said second pricing engine for performing simulation-based computations in which a plurality of scenarios are applied to market data to generate a plurality of valuation and exposure measures;

e) a fourth risk engine connected to said second pricing engine and said third engine for computing a plurality of risk and reward metrics from said valuation and exposure measures; and

f) a report generator connected to said fourth risk engine for generating reports for use in managing risk; and

g) wherein acts performed by said first calibration engine, said second pricing engine said third engine, said fourth risk engine and said report generator are configured to execute on a computer.

2. The system as claimed in claim 1, wherein at least one of said one or more credit instruments is a loan.

3. The system as claimed in claim 1, further comprising at least one input data module for storing data relating to credit instruments in said database.

4. The system as claimed in claim 1, further comprising a portfolio hierarchy server.

5. The system as claimed in claim 1, wherein said first calibration engine comprises:

a) a first module for generating one or more basis instruments from input data relating to said one or more credit instruments, wherein said input data comprises at least one of prices, ratings, sectors, and terms and conditions;

b) a second module for generating a first term structure of risk-free zero prices and a risk-neutral process for interest rates from said one or more basis instruments;

c) a third module for generating one or more basic spread matrices from said one or more basis instruments and said first term structure of risk-free zero prices;

d) a fourth module for generating a second term structure of risk-neutral transition matrices and at least one smoothed credit spread matrix using said first term structure of risk-free zero prices, said module also configured to develop generators using a transition matrix manager;

e) a fifth module for generating a third term structure of risk-neutral transition matrices for a specific named obligor from said at least one smoothed credit spread matrix, said first term structure of risk-free zero prices, and said second term structure of risk-neutral transition matrices; and

f) a sixth module for generating a plurality of spread volatility matrices.

6. The calibration engine of claim 5, wherein at least one of said modules of said calibration engine generates data subsequently stored in a Mark-to-Future cube.

7. The system of claim 1, wherein said second pricing engine comprises:

a) a first module for defining a state space;

b) a second module for generating a state space by modeling the underlying economic behavior driving the exercise of embedded options and other structural features of said plurality of credit instruments;

c) a third cash flow generation module for generating cash flows for said plurality of credit instruments, whereby said credit instruments may be subject to different prepayment or credit state assumptions; and

d) a fourth module connected to said third cash flow generation module for generating a plurality of valuation attributes from said generated cash flows.

8. The system of claim 1, wherein the net present value of a credit instrument is calculated by performing a valuation of a plurality of cash flows for the credit instrument.

9. The system of claim 8, wherein said valuation of said plurality of cash flows is performed using a lattice valuation technique.

10. The system of claim 8, where said valuation of said plurality of cash flows is performed using a Monte Carlo simulation technique.

11. The system of claim 1, wherein the par spread of a credit instrument is calculated by determining one or more spreads such that the net present value of the credit instrument equals a specified value.

13. The system of claim 1, wherein the first calibration engine is further configured to classify, filter, create an interest rate model, a prior yield curve model and develop a rating based model construction process.

14. The system of claim 13, wherein the rating based model construction process uses a multiple transformation function for empirical transition matrices.

15. The system of claim 14, wherein the multiple transformation function is one of a Jarrow-Lando-Turnbull and a Jijima &

Komoribayashi model.

12. A no-arbitrage-based system for valuing one or more credit instruments, said system comprising:

a) a database having a machine readable storage medium for storing credit instrument data;

b) a first calibration engine connected to said database, wherein said first calibration engine generates calibration parameters from said credit instrument data and current market data, said credit instrument data comprising market data;

c) a second pricing engine connected to said database and said first calibration engine, wherein said second pricing engine is configured to use said calibration parameters to value said one or more credit instruments according to no-arbitrage financial principles, wherein at least one of a net present value and a par-spread is calculated for each of said one or more credit instruments using current market data;

d) a third engine connected to said second pricing engine for performing simulation-based computations in which a plurality of scenarios are applied to market data to generate a plurality of valuation and exposure measures;

e) a fourth risk engine connected to said second pricing engine and said third engine for computing a plurality of risk and reward metrics from said valuation and exposure measures; and

f) a report generator connected to said fourth risk engine for generating reports for use in managing risk, wherein the second pricing engine is configured to produce at least one risk-neutral transition matrix;

wherein acts performed by said first calibration engine, said second pricing engine said third engine, said fourth risk engine and said report generator are configured to execute on a computer.

16. A no-arbitrage-based system for valuing one or more credit instruments, said system comprising:

a) a database having a machine readable storage medium for storing credit instrument data;

b) a first calibration engine connected to said database, wherein said first calibration engine generates calibration parameters from said credit instrument data and current market data, said credit instrument data comprising market data, the first calibration engine having a first module for generating one or more basis instruments from input data relating to said one or more credit instruments, wherein said input data comprises at least one of prices, ratings, sectors, and terms and conditions, a second module for generating a first term structure of risk-free zero prices and a risk-neutral process for interest rates from said one or more basis instruments, a third module for generating one or more basic spread matrices from said one or more basis instruments and said first term structure of risk-free zero prices, a fourth module for generating a second term structure of risk-neutral transition matrices and at least one smoothed credit spread matrix using said first term structure of risk-free zero prices, said module also configured to develop generators using a transition matrix manager, a fifth module for generating a third term structure of risk-neutral transition matrices for a specific named obligor from said at least one smoothed credit spread matrix, said first term structure of risk-free zero prices, and said second term structure of risk-neutral transition matrices, and a sixth module for generating a plurality of spread volatility matrices;

c) a second pricing engine connected to said database and said first calibration engine, wherein said second pricing engine is configured to use said calibration parameters to value said one or more credit instruments according to no-arbitrage financial principles, wherein at least one of a net present value and a par-spread is calculated for each of said one or more credit instruments using current market data, having a first module for defining a state space, a second module for generating a state space by modeling the underlying economic behavior driving the exercise of embedded options and other structural features of said plurality of credit instruments, a third cash flow generation module for generating cash flows for said plurality of credit instruments, whereby said credit instruments may be subject to different prepayment or credit state assumptions, and a fourth module connected to said third cash flow generation module for generating a plurality of valuation attributes from said generated cash flows,

d) a third engine connected to said second pricing engine for performing simulation-based computations in which a plurality of scenarios are applied to market data to generate a plurality of valuation and exposure measures;

e) a fourth risk engine connected to said second pricing engine and said third engine for computing a plurality of risk and reward metrics from said valuation and exposure measures; and

f) a report generator connected to said fourth risk engine for generating reports for use in managing risk, and

g) wherein acts performed by said first calibration engine, said second pricing engine said third engine, said fourth risk engine and said report generator are configured to execute on a computer.