System and method for pricing default insurance

• US 7,774,255 B2
• Filed: 10/17/2002
• Issued: 08/10/2010
• Est. Priority Date: 12/14/2001
• Status: Active Grant

• Current Assignee: Morgan Stanley Services Group Inc. (Morgan Stanley)
• Original Assignee: Morgan Stanley
• Inventors: Lee, Shinghoi, Zhang, Zhifeng, Cotton, Peter, Pang, Kin
• Primary Examiner(s): Colbert; Ella
• Assistant Examiner(s): Malhotra; Sanjeev
• Application Number:
  US10/274,536
• Publication Number:
  US 20030115125A1
• Time in Patent Office: 2,854 Days
• Field of Search: 705/36, 705/37, 705/38, 705/35, 705/36.R, 705/50
• US Class Current: 705/36.00R
• 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 40/06 Asset management; Financial planning or analysis
• CPC Class Codes: G06Q 40/08 Insurance

Abstract

A system for modeling a basket of securities containing a plurality of securities is provided and includes a default/recovery model database for storing default/recovery data regarding the plurality of securities. Also included is a default simulation engine for calculating a default time for at least one of the plurality of securities based on the default/recovery data. Finally, a cash flow engine is included for generating cash flows for the basket of securities based on the default times.

Claims

1. A method for calculating default times for securities contained in a basket of securities, wherein said method is implemented with a computer system comprising one or more computer processors, said method comprising the steps of:

determining, with at least one of said one or more computer processors, for each of said securities, a hazard rate that is a stochastic process that represents the instantaneous probability of default for a corresponding one of said securities, wherein said hazard rates are correlated;

determining, with at least one of said one or more computer processors, for each of said securities, a compensator based on integrating the hazard rate associated with the corresponding one of said securities over time;

determining, with at least one of said one or more computer processors, for each of said securities, a barrier value selected according to a multivariate distribution of barriers with exponential marginals, thereby establishing random correlated barriers;

the method also comprising the steps of;

(a) determining, with at least one of said one or more computer processors, a proposed default time increment value;

(b) determining, with at least one of said one or more computer processors, a current proposed default time by adjusting a prior proposed default time based on the proposed default time increment value;

(c) calculating, with at least one of said one or more computer processors, for each of a plurality of said securities, a compensator value of said compensator associated with said corresponding security at said current proposed default time;

(d) determining, with one of said one or more computer processors, for each of said plurality of securities, whether said corresponding compensator value is in a relative relationship with said corresponding barrier value, and if so assigning a default time to said corresponding security based on said current proposed default time; and

(e) repeating steps (a)-(d) at least with respect to one or more unassigned securities.

2. The method of claim 1, wherein the step of determining random correlated barriers includes the steps of:

determining normally distributed random numbers X_k; and

setting the barriers B_k according to the formula B_k =−

log(1−

invnormcdf(X_k)).

3. The method of claim 1, wherein the step of determining a hazard rate for each of said securities includes the step of:

calibrating a specification of dependence between hazard rates based on correlation information.

4. The method of claim 3, wherein said correlation information is based on historical time series of default swap.

5. The method of claim 3, wherein said correlation information is based on historical time series of bond spreads.

6. The method of claim 3, wherein said correlation information is based on historical time series of bond ratings.

7. The method of claim 3, wherein said correlation information is based on market prices of basket default swaps.

8. The method of claim 3, wherein said correlation information is based on option market pricing.

9. The method of claim 1, wherein said prior proposed default time comprises an initialized proposed default time and said initialized proposed default time is set to zero.

10. The method of claim 1, wherein the step of determining said proposed default time increment value is based on calculating, for each of said plurality of said securities, a value based at least on said barrier value and said compensator associated with said corresponding one of said plurality of said securities.

11. The method of claim 10, wherein the step of determining of said proposed default time increment value further comprises selecting a smallest value of said values and basing said proposed default time increment value on said smallest value.

12. The method of claim 1, wherein the step of determining said proposed default time increment value is based on calculating, for each of said plurality of said securities, a value based at least on said barrier value and said hazard rate associated with said corresponding one of said plurality of said securities.

13. The method of claim 12, wherein said value is a ratio of said barrier value and said hazard rate at time zero.

14. The method of claim 13, wherein the step of determining said proposed default time increment value further comprises selecting a smallest value of said values and basing said proposed default time increment value on said smallest value.

15. The method of claim 1, further comprising the step of calculating, with at least one of said one or more computer processors, for each of a plurality of said securities, a hazard rate value of said compensator associated with said corresponding one of said plurality of said securities at said current proposed default time.

16. The method of claim 15, wherein the step of determining said proposed default time increment value is based on calculating, for each of said plurality of said securities, a value based at least on said barrier value, said compensator, and said hazard rate associated with said corresponding one of said plurality of said securities.

17. The method of claim 16, wherein said value is a ratio of a difference of said barrier value and said compensator value to said hazard rate value.

18. The method of claim 17, wherein the step of determining said proposed default time increment value further comprises selecting a smallest value of said values and basing said proposed default time increment value on said smallest value.

19. The method of claim 15, wherein said step of assigning a default time to said corresponding security based on said current proposed default time comprises adjusting said current proposed default time based on a ratio of a difference of said barrier value and said compensator value to said hazard rate value, for said corresponding security.

20. The method of claim 1, wherein said step of assigning a default time to said corresponding security based on said current proposed default time comprises adjusting said current proposed default time based on a time adjustment selected so that the expected value of the exponential of the negative of said compensator at an adjusted time is equal to the exponential of the negative of the barrier value, wherein the adjusted time is said current proposed default time added to said time adjustment.

21. The method of claim 1, wherein the relative relationship comprises said corresponding compensator value is greater than said corresponding barrier value.

22. The method of claim 1, wherein the relative relationship comprises said corresponding compensator value is greater than or sufficiently close to said corresponding barrier value.

23. The method of claim 1, further comprising the step of determining whether said corresponding compensator value is sufficiently close to said corresponding barrier value by determining whether said corresponding compensator value is within a selected percentage of said corresponding barrier value.

24. A method for calculating default times for securities contained in a basket of securities, wherein said method is implemented with a computer system comprising one or more computer processors, said method comprising the steps of:

determining, with at least one of said one or more computer processors, for each of said securities, a hazard rate that is a stochastic process that represents the instantaneous probability of default for a corresponding one of said securities, wherein said hazard rates are correlated;

determining, with at least one of said one or more computer processors, for each of said securities, a compensator based on integrating the hazard rate associated with the corresponding one of said securities over time;

determining, with at least one of said one or more computer processors, for each of said securities, a barrier value selected according to a multivariate distribution of barriers with exponential marginals, thereby establishing random correlated barriers;

the method also comprising the steps of;

(a) determining, with at least one of said one or more computer processors, a proposed default time increment value;

(b) determining, with at least one of said one or more computer processors, a current proposed default time by adjusting a prior proposed default time based on the proposed default time increment value;

(c) calculating, with at least one of said one or more computer processors, for each of a plurality of said securities, a compensator value of said compensator associated with said corresponding security at said current proposed default time;

(d) determining, with at least one of said one or more computer processors, for each of said plurality of said securities, an adjusted default time based on said corresponding compensator and said corresponding barrier value, and determining, based on said adjusted default time, whether to assign a default time to said corresponding security, where said default time is based on said current proposed default time; and

(e) repeating steps (a)-(d) at least with respect to one or more unassigned securities.

25. The method of claim 24, wherein said prior proposed default time comprises an initialized proposed default time and said initialized proposed default time is set to zero.

26. The method of claim 24, further comprising the step of calculating, with at least one of said one or more computer processors, for each of a plurality of said securities, a hazard rate value of said compensator associated with said corresponding one of said plurality of said securities at said current proposed default time.

27. The method of claim 26, wherein said step of determining an adjusted default time comprises determining said adjusted default time based at least on said corresponding compensator value, said corresponding barrier value and said corresponding hazard rate value.

28. The method of claim 26, wherein said step of determining an adjusted default time comprises determining said adjusted default time based at least on a ratio of a difference of said barrier value and said compensator value to said hazard rate value, for said corresponding security.

29. The method of claim 24, further comprising the step of assigning the default time to said corresponding security, where said default time is based on adjusting said current proposed default time based on said adjusted default time of said corresponding security.