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Global valuation and dynamic risk management Claudio Albanese, Guillaume Gimonet and Steve White

Summary: Global valuation and dynamic risk management
Claudio Albanese, Guillaume Gimonet and Steve White
November 5, 2010
1 Market standards
Some instruments such as interest rate swaps and variance swaps, admit low-risk, fairly ro-
bust replication strategies that do not rely on probabilistic models. As a consequence, these
instruments are traded with confidence and they are among the most liquid pillars of financial
markets. Vice-versa, instruments which cannot be easily replicated are not liquid and require
model-based valuation.
To arrive at a consensus around valuations of illiquid instruments, the finance industry has
structured itself around standards. Valuation methodologies have historically followed cycles
whereby innovations were promoted, disseminated and finally established into industry-wide
standards. Rating methodologies developed into standards for the sake of maintaining consis-
tency. Risk management methodologies developed significantly in the 1990s after the introduc-
tion of value-at-risk (VaR) measures [29] and mark-to-market and mark-to-model accounting.
Capital adequacy directives subsequently encoded the industry practice into a regulatory frame-
Standards are double-edged swords. Markets benefit from standards as these facilitate com-
munication and mutual risk assessments, thus enhancing confidence and trading volumes. Stan-
dards are beneficial because they provide a measure of stability, facilitate the commoditisation


Source: Albanese, Claudio - Department of Mathematics, King's College London


Collections: Mathematics