System and method for pricing default insurance

• US 7,818,242 B1
• Filed: 06/24/2010
• Issued: 10/19/2010
• Est. Priority Date: 12/14/2001
• Status: Expired due to Term

• Current Assignee: Morgan Stanley Services Group Inc. (Morgan Stanley)
• Original Assignee: Morgan Stanley
• Inventors: Zhang, Zhifeng, Cotton, Peter, Pang, Kin, Lee, Shinghoi
• Primary Examiner(s): Colbert; Ella
• Assistant Examiner(s): Malhotra; Sanjeev
• Application Number:
  US12/822,927
• Publication Number:
  US 20100262439A1
• Time in Patent Office: 117 Days
• Field of Search: 705/35, 705/36.R, 705/37, 705/38, 706/50
• 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 system for calculating default times for securities contained in a basket of securities, comprising:

one or more computer processors; and

memory comprising program instructions, wherein the program instructions are executable by at least one of said one or more processors to;

(a) determine, 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;

(b) determine, 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;

(c) determine, 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;

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

(e) determine, 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;

(f) calculate, 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;

(g) determine, with at least 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

(h) repeat steps (d)-(g) at least with respect to one or more unassigned securities.

2. The system of claim 1, wherein said at least one of said one or more computer processors determines random correlated barriers by at least:

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 system of claim 1, wherein said at least one of said one or more computer processors determines a hazard rate for each of said securities by at least calibrating a specification of dependence between hazard rates based on correlation information.

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

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

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

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

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

9. The system 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 system of claim 1, wherein said at least one of said one or more computer processors determines said proposed default time increment value 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 system of claim 10, wherein said at least one of said one or more computer processors determines said proposed default time increment value by at least selecting a smallest value of said values and basing said proposed default time increment value on said smallest value.

12. The system of claim 1, wherein said at least one of said one or more computer processors determines said proposed default time increment value 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 system of claim 12, wherein said value is a ratio of said barrier value and said hazard rate at time zero.

14. The system of claim 1, wherein said at least one of said one or more computer processors determines said proposed default time increment value based at least on selecting a smallest value of said values and basing said proposed default time increment value on said smallest value.

15. The system of claim 1, wherein the program instructions are further executable by the at least one of said one or more computer processors to calculate, 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 system of claim 15, wherein said at least one of said one or more computer processors determines said proposed default time increment value by at least 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 system 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 system of claim 17, wherein said at least one of said one or more computer processors determines said proposed default time increment value by at least selecting a smallest value of said values and basing said proposed default time increment value on said smallest value.

19. The system of claim 15, wherein 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 system of claim 1, wherein 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 system of claim 1, wherein the relative relationship comprises said corresponding compensator value is greater than said corresponding barrier value.

22. The system 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 system of claim 1, wherein the program instructions are further executable by at least one of said one or more processors to determine 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. The system of claim 1, further comprising a cash flow engine that generates cash flows for said basket of securities based on said default times.

25. The system of claim 24, further comprising a basket information database that stores information for a basket of securities, wherein the basket information database is operatively connected to at least the cash flow engine to provide information for a basket of securities to the cash flow engine.

26. The system of claim 25, wherein the information for a basket of securities includes collateral, capital structure and waterfall information for a basket of securities.

27. The system of claim 24, further comprising a scenario aggregator that stores cash flows for said basket of securities generated by the cash flow engine and computing statistics based on the stored cash flows.

28. The system of claim 24, further comprising a valuation/pricing module that performs a valuation of said basket of securities based on said default time.

29. The system of claim 24, further comprising a risk assessment module that performs a risk assessment on said basket of securities based on said default times.

30. The system of claim 29, wherein said risk assessment module calculates an insurance premium associated with a default of said at least one of a plurality of securities based on said default time.

31. A system for calculating default times for securities contained in a basket of securities, comprising:

one or more computer processors; and

memory comprising program instructions, wherein the program instructions are executable by at least one of said one or more processors to;

(a) determine, 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;

(b) determine, 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;

(c) determine, 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;

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

(e) determine, 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;

(f) calculate, 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;

(g) determine, 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

(h) repeat steps (d)-(g) at least with respect to one or more unassigned securities.

32. The system of claim 31, wherein said prior proposed default time comprises an initialized proposed default time and said initialized proposed default time is set to zero.

33. The system of claim 31, wherein the program instructions are further executable by at least one of said one or more processors to calculate, 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.

34. The system of claim 33, wherein said at least one of said one or more computer processors determines an adjusted default time by at least determining said adjusted default time based at least on said corresponding compensator value, said corresponding barrier value and said corresponding hazard rate value.

35. The system of claim 33, wherein said at least one of said one or more computer processors determines an adjusted default time by at least 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.

36. The system of claim 31, wherein the program instructions are further executable by at least one of said one or more processors to assign 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.

37. The system of claim 31, further comprising a cash flow engine that generates cash flows for said basket of securities based on said default times.

38. The system of claim 37, further comprising a basket information database that stores information for a basket of securities, wherein the basket information database is operatively connected to at least the cash flow engine to provide information for a basket of securities to the cash flow engine.

39. The system of claim 38, wherein the information for a basket of securities includes collateral, capital structure and waterfall information for a basket of securities.

40. The system of claim 37, further comprising a scenario aggregator that stores cash flows for said basket of securities generated by the cash flow engine and computing statistics based on the stored cash flows.

41. The system of claim 37, further comprising a valuation/pricing module that performs a valuation of said basket of securities based on said default time.

42. The system of claim 37, further comprising a risk assessment module that performs a risk assessment on said basket of securities based on said default times.

43. The system of claim 42, wherein said risk assessment module calculates an insurance premium associated with a default of said at least one of a plurality of securities based on said default time.