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Model
Development
Process
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Introduction

1. Liquidity Horizon model was developed to predict the


liquidity of the traded credit products.
2. This was one model which enabled bank to comply
with BASEL guidelines for IRC (Incremental Risk
Charge) calculation.
3. Model addressed following tasks:
• Examine the liquidity of traded credit products.
• Consider the hedging impact on the liquidity period.
• Statistical analysis of the market liquidity for the
traded credit products.
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Model Development steps:

Step 1: Defining the Objective


Step 2: Gathering the Data
Step 3: Preparing the Data for Modeling
Step 4: Selecting the Variables
Step 5: Processing and Evaluating the Model
Step 6: Validating the Model
Step 7: Implementing and Maintaining the Model
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Step 1: Defining the Objective

• The objective of LH model was to estimate liquidity


period for traded credit products (primarily Bonds, CDS
& Loans)

• Comparing the actual Realized Time to Liquidation


(RTL) against the model generated liquidity period.

• Analyzing the hedging impact on the liquidity period of


the product.
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Step 2: Gathering the Data

• The dataset consists of all the trades between the


period Oct 2008 till Sep 2009 and sourced from various
trade systems.

• To get large volume of data, both live and dead trades


have been included.

• Data excluded all the trades where Credit Suisse was


the counterparty as this could potentially skew the
results.
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Step 3: Preparing the Data for Modeling

• Data Accuracy (unusual values, outliers).

• Data completeness (Are missing values important).

• Data imputation (for missing values)

• Data sampling (to select 30 random samples from each


traded credit products).
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Step 4: Selecting the Variables

• Stepwise regression was performed to select the


significant variables for the model.

• Data was segmented in three product categories Bond,


CDS and Loan.
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Step 5: Processing and Evaluating the
Model
• Linear regression model was used to estimate liquidity
period for the traded credit products.
• Bid/Ask spread was used as a proxy for market liquidity
for the products. This was our response or dependent
variable.
• Bid/Ask spread was bucketed into 10D, 20D, 40D, 60D
& 120D.
• Primary response or predictor variables were Ratings,
Maturity, Sector, Region and Currency.
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Step 6: Validating the Model

• Actual realized time to liquidation is compared with


model predicted liquidity period for test sample.

• Residual/error analysis was done to examine the model


performance.

• Input sensitivity test: applying shift to independent


variables and compare the predicted liquidity with the
baseline.
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Step 7: Implementing and Maintaining
the Model
• Once model was developed and validated, it was
implement within in the Front Office trading system .
• User Acceptance Test(UAT) was performed to ensure
model is implemented correctly and outcomes are sync
with desired outcomes.
• Entire process of model development and methodology
was documented in model document.
• Team was designated to monitor performance of the
model on a periodic basis. Monitor performance of the
models on a periodic basis
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Questions & Answers