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ADVANCED CREDIT RISK

MEASUREMENT AND
MODELLING TECHNIQUES
for effective portfolio credit risk management

NEW YORK, 5 & 6 SEPTEMBER 2002


LONDON, 19 & 20 SEPTEMBER 2002

COURSE HIGHLIGHTS: COURSE LEADERS:


• Compare and contrast the leading portfolio credit Colin Burke, ABBEY NATIONAL TREASURY SERVICES
risk modelling techniques Alla Gil, CITIGROUP
• Default modelling with copula functions Paul Hawkins, MERRILL LYNCH INTERNATIONAL
Frank Iacono, LEHMAN BROTHERS INC.
• Predicting and determining loss given default
Ludger Overbeck, DEUTSCHE BANK AG
• Analyse new trends in portfolio capital Dr. Dmitry Pugachevsky, BEAR STEARNS & CO.
management
Dr. Philipp J. Schönbucher, UNIVERSITY OF BONN
• Structure and evaluate synthetic CDOs Bob Selvaggio, AMBAC FINANCIAL GROUP, INC.

PRACTICAL WORKED EXAMPLES AND CASE STUDIES:


• Construct the loss distribution function and calculate the expected loss for a real portfolio of corporate names
• Parameterise and calibrate a sample portfolio using comparative credit risk models
• Construct a calibrated spread curve
• Derive default probabilities from equity prices
• Use historical simulation to evaluate the performance of a traditional synthetic CDO

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ADVANCED CR
PORTFOLIO CR
NEW YORK, 5 & 6 September 2002
NEW YORK, Thursday 5 September 2002
8.45 3.15 Afternoon break
MODELLING DEFAULT RISK USING ASSET-BASED APPROACHES
· Structural models: Merton model 3.45
- examining key assumptions and limitations MODELS FOR PORTFOLIO CREDIT RISK MANAGEMENT:
- term structure of credit spreads UNDERSTANDING THE ANALYTICS, CALIBRATION AND
- empirical evidence PERFORMANCE OF THE LEADING ALTERNATIVE
- recovery rates and absolute priority APPROACHES
· Commercial implementation of the model: The KMV approach · A critical examination of leading portfolio credit risk modelling
techniques
CASE STUDY: Deriving default probabilities from equity - CreditMetrics
prices: How it works and why it “missed” with Enron - CreditRisk+
- KMV/Moody's
Philipp J. Schönbucher, Assistant Professor, Department of Statistics - Generalised framework, common ground and key differences
UNIVERSITY OF BONN · Selecting the most appropriate model for your portfolio
· How does each model use market information?
10.15 Morning break · An analysis of the new models for portfolio credit risk management

10.45 PRACTICAL WORKED EXAMPLE: Parameterisation and


ANALYSING SPREAD-BASED MODELS OF DEFAULT RISK calibration of a sample portfolio using comparative credit risk
· Credit spread curves and implied default probabilities models
- extracting information from market prices
· Practical application of a transition matrix model for modelling Bob Selvaggio, Managing Director, Risk Analysis and Reporting
portfolio credit risk AMBAC FINANCIAL GROUP, INC.
· Recovery modelling
- the impact of recovery rate on implied probabilities 5.30 End of day one
· Models of the default time
- Poisson and Cox processes
· Default modelling with copula functions
· Correlated defaults in spread-based models

PRACTICAL WORKED EXAMPLE: Constructing a calibrated


spread curve NEW YORK, Friday 6 September 2002
Philipp J. Schönbucher, Assistant Professor, Department of Statistics
UNIVERSITY OF BONN 8.45
CAPITAL MANAGEMENT FOR CREDIT RISKY PORTFOLIOS
12.15 Lunch break · New trends in portfolio capital management
· Integration of market and credit risk
1.15 · Generalising value-at-risk approach
ESTIMATING AND MODELLING RECOVERY RATES · Measuring capital required to cover the portfolio risks
· Regularities in historical recovery rates · Minimising portfolio capital needs
· Predicting loss given default: LossCalcTM · Different ways to implement transition from current to optimal
· Loss given default and recovery correlation risk portfolio
- how to determine loss given default
- internal assumptions on LGD PRACTICAL WORKED EXAMPLE: Construct the loss
- overcoming the problems of a lack of data distribution function and calculate the expected loss of a
- robustness results portfolio. Identify market and credit risk numbers for the
Philipp J. Schönbucher, Assistant Professor, Department of Statistics portfolio and discover the changes necessary to minimise the
UNIVERSITY OF BONN required capital. Analyse the various transactions used to
implement the required changes
2.00
FACTOR MODELS OF PORTFOLIO CREDIT RISK Alla Gil, Managing Director, Head of Strategic Risk Advisory and
· Conditionally independent defaults: The Binomial distribution Modelling Group
· The one-factor Vasicek model and its resulting returns distributions CITIGROUP
· Multi factor models
· Calibration and estimation 10.15 Morning break
· Econometric estimation
10.35
PRACTICAL WORKED EXAMPLE: Calibrating a factor model EFFECTIVE PRICING OF CREDIT DERIVATIVES FOR
to historical default frequencies PORTFOLIO CREDIT RISK MANAGEMENT
· Constructing spot/forward credit curves to price credit derivatives
Philipp J. Schönbucher, Assistant Professor, Department of Statistics · Examining alternative methods to price credit default swaps
UNIVERSITY OF BONN · Components of the credit spread and the impact of liquidity

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EDIT RISK MEASUREMENT AND MODELLING TE
REDIT RISK MANAGEMENT

LONDON, Thursday 19 September 2002


· Evaluating the key components of theoretical credit swap pricing 8.45
· Overcoming the problems of a lack of data MODELLING DEFAULT RISK USING ASSET-BASED APPROACHES
- selecting the most accurate and appropriate data source for pricing · Structural models: Merton model
- assessing data quality and completeness - examining key assumptions and limitations
- overcoming the problems in estimating historical volatility - term structure of credit spreads
· Applying credit derivatives to manage portfolio credit risk - empirical evidence
- recovery rates and absolute priority
PRACTICAL WORKED EXAMPLE: Pricing a credit derivative · Commercial implementation of the model: The KMV approach
basket
CASE STUDY: Deriving default probabilities from equity
Alla Gil, Managing Director, Head of Strategic Risk Advisory and prices: How it works and why it “missed” with Enron
Modelling Group
CITIGROUP Philipp J. Schönbucher, Assistant Professor, Department of Statistics
UNIVERSITY OF BONN
12.05 Lunch break
10.15 Morning break
1.05
MODELLING DEFAULT CORRELATION FOR PORTFOLIO 10.45
CREDIT RISK MEASUREMENT ANALYSING SPREAD-BASED MODELS OF DEFAULT RISK
· Event correlation · Credit spread curves and implied default probabilities
· Importance of correlation - extracting information from market prices
- extreme cases - uncorrelated and perfectly correlated credits · Practical application of a transition matrix model for modelling
· Comparison of different structural approaches portfolio credit risk
- Merton approach: Single- and multi-period · Recovery modelling
- normal copula - the impact of recovery rate on implied probabilities
- t-Student copula · Models of the default time
- Hull-White approach - Poisson and Cox processes
· Sources of correlation data · Default modelling with copula functions
· Correlated defaults in spread-based models
PRACTICAL WORKED EXAMPLE: The effect of copula
specification on default probabilities and loss distributions PRACTICAL WORKED EXAMPLE: Constructing a calibrated
spread curve
Dmitry Pugachevsky, Managing Director, Head of Credit Derivatives
Analytics Philipp J. Schönbucher, Assistant Professor, Department of Statistics
BEAR STEARNS & CO. UNIVERSITY OF BONN

3.00 Afternoon break 12.15 Lunch break

3.30 1.15
USING HISTORICAL SIMULATION TO MEASURE THE ESTIMATING AND MODELLING RECOVERY RATES
RELATIVE VALUE OF SYNTHETIC CDO TRANCHES · Regularities in historical recovery rates
· Overview of synthetic CDO market and structures · Predicting loss given default: LossCalcTM
· Interpreting the cohort default data · Loss given default and recovery correlation risk
· Sampling the data to simulate default experience in a model reference - how to determine loss given default
portfolio - internal assumptions on LGD
· Applying the resulting loss distribution to a model of synthetic CDO - overcoming the problems of a lack of data
structures - robustness results
· Evaluating measures of risk and reward for the underlyings and the Philipp J. Schönbucher, Assistant Professor, Department of Statistics
tranches UNIVERSITY OF BONN
- expected loss
- variability of loss 2.00
- variation in these measures over time FACTOR MODELS OF PORTFOLIO CREDIT RISK
· Recognising the weaknesses of this approach · Conditionally independent defaults: The Binomial distribution
· The one-factor Vasicek model and its resulting returns distributions
PRACTICAL WORKED EXAMPLE: Using historical · Multi factor models
simulation based on rating cohort data to evaluate the · Calibration and estimation
performance of a traditional synthetic CDO, referencing a · Econometric estimation
diversified portfolio of high-grade corporate entities
PRACTICAL WORKED EXAMPLE: Calibrating a factor model
Frank Iacono, Senior Vice President to historical default frequencies
LEHMAN BROTHERS INC.
Philipp J. Schönbucher, Assistant Professor, Department of Statistics
5.00 End of course UNIVERSITY OF BONN

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ECHNIQUES FOR EFFECTIVE

LONDON, 19 & 20 September 2002

3.15 Afternoon break · Overcoming the problems of a lack of data


- selecting the most accurate and appropriate data source for pricing
3.45 - assessing data quality and completeness
MODELS FOR PORTFOLIO CREDIT RISK MANAGEMENT: - overcoming the problems in estimating historical volatility
UNDERSTANDING THE ANALYTICS, CALIBRATION AND · Applying credit derivatives to manage portfolio credit risk
PERFORMANCE OF THE LEADING ALTERNATIVE
APPROACHES PRACTICAL WORKED EXAMPLE: Pricing a credit derivative
· A critical examination of leading portfolio credit risk modelling basket
techniques
- KMV/CreditMetrics Alla Gil, Managing Director, Head of Strategic Risk Advisory and
- CreditRisk+ Modelling Group
- Generalised framework, common ground and key differences CITIGROUP
· Sensitivity to portfolio composition: Selecting the most appropriate
model for your portfolio 12.05 Lunch break
· Implementation issues - overcoming the problem of a lack of data
1.05
PRACTICAL WORKED EXAMPLE: Parameterisation and MODELLING DEFAULT CORRELATION FOR PORTFOLIO
calibration of a sample portfolio using comparative credit risk CREDIT RISK MEASUREMENT
models · Default correlations: Small but dangerous
· Use of copulas in modelling default correlation - conditional
Colin Burke, Senior Quantitative Analyst copulas/default time copulas
ABBEY NATIONAL TREASURY SERVICES · Copulas vs. correlation
· Sources of correlation data
5.30 End of day one · Generation of correlated random variates for portfolio modelling
· Ability-to-pay correlations vs. event correlations
· New results on correlation estimates based on asset time series and
default data

CASE STUDY: Stressed default probabilities in a portfolio of


correlated credits
LONDON, Friday 20 September 2002
Ludger Overbeck, Head of Risk Research and Development
DEUTSCHE BANK AG
8.45
CAPITAL MANAGEMENT FOR CREDIT RISKY PORTFOLIOS 3.00 Afternoon break
· New trends in portfolio capital management
· Integration of market and credit risk 3.30
· Generalising value-at-risk approach EXECUTING SYNTHETIC SECURITISATIONS AND CBO/CLOs
· Measuring capital required to cover the portfolio risks TO TRANSFER PORTFOLIO CREDIT RISK
· Minimising portfolio capital needs · Cash vs. synthetic - how to choose the most appropriate approach for
· Different ways to implement transition from current to optimal your transaction
portfolio · What is a synthetic securitisation?
· How to structure a synthetic securitisation
PRACTICAL WORKED EXAMPLE: Construct the loss - new structural developments for synthetic securitisations
distribution function and calculate the expected loss of a - rating agency modelling of synthetics
portfolio. Identify market and credit risk numbers for the · Putting synthetic securitisations to effective use
portfolio and discover the changes necessary to minimise the - understanding the advantages of synthetic securitisations
required capital. Analyse the various transactions used to - who benefits from synthetics?
implement the required changes · Modelling and pricing synthetic securitisations

Alla Gil, Managing Director, Head of Strategic Risk Advisory and CASE STUDY: Leonardo - Aircraft portfolio risk transfer
Modelling Group
CITIGROUP Paul Hawkins, Vice President, Securitisation & Portfolio Credit
Derivatives
10.15 Morning break MERRILL LYNCH INTERNATIONAL

10.35 5.00 End of course


EFFECTIVE PRICING OF CREDIT DERIVATIVES FOR
PORTFOLIO CREDIT RISK MANAGEMENT
· Constructing spot/forward credit curves to price credit derivatives
· Examining alternative methods to price credit default swaps
· Components of the credit spread and the impact of liquidity
· Evaluating the key components of theoretical credit swap pricing

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COURSE LEADERS

Colin Burke, ABBEY NATIONAL TREASURY SERVICES Ludger Overbeck, DEUTSCHE BANK AG
(London course) (London course)
Colin Burke is a Senior Quantitative Analyst at Abbey Ludger Overbeck is Head of Risk Research and Development,
National Treasury Services specialising in credit portfolio and CIB/Credit Risk Management at Deutsche Bank AG,
economic capital modelling. As such he has designed and Frankfurt, since May 2000. His main projects include: Credit
developed Monte Carlo simulation and default correlation portfolio models for RAROC purpose; analytic support for
models and applied these to portfolio analysis and CDO portfolio management; analytic support for exposure
structuring and analysis. He has also built and tested sovereign management; integration of market and credit risk; risk
default models. assessment for CLOs and basket credit derivatives and analytic
Prior to joining ANTS, Colin has held a number of positions support for operational risk. Prior to this he was responsible for
at Barclays and ING Barings. He holds a BSc and Ph.D. in Group Market Risk Management, methodology and policy for
Physics from King's College, London. credit risk and portfolio models. Ludger also lectures at the
universities in Bonn (Department of Applied Mathematics)
Alla Gil, CITIGROUP and Frankfurt (Department of Business and Economics).
(London and New York courses)
Alla Gil is a Managing Director and the Head of Strategic Dmitry Pugachevsky, BEAR STEARNS & CO.
Risk Advisory and Modelling Group at Citigroup. In this role (New York course)
she is responsible for the development of the new risk Dmitry Pugachevsky is a Managing Director and the Head of
assessment and mitigation methodologies and advising the Credit Derivatives Analytics of Bear Stearns Co. Prior to
senior management of major Citigroup's clients on currency joining Bear Stearns in 2001, he worked for eight years with
risk, interest rate risk, credit risk as well as asset/liability, and analytics groups of Bankers Trust and Deutsche Bank,
economic capital management and optimisation. developing models for credit, fixed income, and equity
Prior to Citigroup Alla spent 3 years at Goldman Sachs derivatives. Dr. Pugachevsky received his Ph.D. in Applied
developing interest rate derivatives models and 2.5 years at Mathematics from Carnegie Mellon University. He has
CIBC developing credit derivatives models. published several papers on modelling credit and fixed income
derivatives and co-authored a pioneering research on passport
Paul Hawkins, MERRILL LYNCH INTERNATIONAL options.
(London course)
Paul Hawkins is a Vice President with responsibilities Philipp Schönbucher, UNIVERSITY OF BONN
structuring and marketing balance-sheet transactions within (London & New York courses)
Merrill Lynch's Securitisation and Portfolio Credit Derivatives Dr. Philipp J. Schönbucher is Assistant Professor at the
group. He was a Structurer for the groundbreaking Leonardo Department of Statistics of the Faculty of Economics at the
and Stratus synthetic aircraft transactions and Igloo French University of Bonn. He holds degrees in Mathematics (Oxford)
loan synthetic securitisation. and Economics (Bonn) and a Ph.D. in Economics. His
Prior to joining Merrill Lynch, Paul worked in a quantitative publications include papers on credit risk modelling, credit
capacity with the Credit Derivatives group at Citibank, N.A. derivatives pricing, stochastic volatility modelling, option
and Salomon Smith Barney where he modelled and structured pricing in illiquid markets, real options and term structure
large portfolio synthetic securitisations. Paul holds a Ph.D. in models. His main area of research is credit risk modelling and
Quantitative Finance at Imperial College, University of credit derivatives pricing in which he has been active since
London, on optimising credit portfolios using economic 1996. Furthermore, he is author of a book on “Credit
capital, and an MA in Mathematics from Cambridge Derivatives Pricing Models” (to appear 2002), and he is
University. consultant and professional trainer to a number of leading
financial institutions.
Frank Iacono, LEHMAN BROTHERS INC.
(New York course) Bob Selvaggio, AMBAC FINANCIAL GROUP, INC.
Frank Iacono is a Senior Vice President of Lehman Brothers, (New York course)
Inc. in the Structured Credit Trading Group in New York. Mr. Bob Selvaggio is a Managing Director of Ambac Financial
Iacono's responsibilities include structuring and trading of Group, Inc. He is responsible for portfolio credit and market
portfolio credit derivatives, including “baskets” and synthetic risk management and the attribution of economic capital.
Collateralised Debt Obligation (“CDO”) products. Prior to Prior to joining Ambac in May 1998, Dr. Selvaggio served as a
joining Lehman, Mr. Iacono was a Vice President in the Financial Economist at Thomson McKinnon Securities, and
Structured Credit Products Group of Chase Securities, Inc. then held a number of positions at the Chase Manhattan Bank
(1998-2001) and a Consultant at Capital Market Risk including Senior Asset/Liability Analyst, Head of Fixed Income
Advisors (1994 - 1998), Inc., a leading risk management and and Mortgage Research, and Managing Director of Treasury
financial engineering consulting firm. Mr. Iacono received a Analytics.
Juris Doctor, cum laude from Harvard Law School, and a A graduate of the University of Pennsylvania, Bob holds a
Bachelor of Science, summa cum laude, from Yale University. Ph.D. in Economics from Brown University. He is a member
of the American Economic Association and National
Association of Business Economists, and is a BAI Certified
Risk Professional.

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ADVANCED CREDIT RISK
MEASUREMENT AND
MODELLING TECHNIQUES
for effective portfolio credit risk management

Code : A B C D E F G H I J K L M N O P Q R S T U V W X Y Z
NEW YORK, 5 & 6 SEPTEMBER 2002
LONDON, 19 & 20 SEPTEMBER 2002
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