Abstract

http://ssrn.com/abstract=1712086
 
 

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Risk Management Models: Construction, Testing, Usage


Robert A. Jarrow


Cornell University - Samuel Curtis Johnson Graduate School of Management

March 15, 2011

Johnson School Research Paper Series No. 38-2010

Abstract:     
Financial risk management models were often used wrongly prior to the 2007 credit crisis, and they are still being used wrongly today. This misuse contributed to the crisis. We show that there are two common misuses of derivative pricing models associated with calibration and hedging β€œthe greeks.” The purpose of this paper is to clarify these misuses and explain how to properly use risk management models. In particular, we show that: (i) the implied default probabilities from structural credit risk models and the default probabilities obtained from credit risk copula models are mispecified, and (ii) vega hedging is a nonsensical procedure.

Number of Pages in PDF File: 17

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Date posted: November 21, 2010 ; Last revised: March 16, 2011

Suggested Citation

Jarrow, Robert A., Risk Management Models: Construction, Testing, Usage (March 15, 2011). Johnson School Research Paper Series No. 38-2010. Available at SSRN: http://ssrn.com/abstract=1712086 or http://dx.doi.org/10.2139/ssrn.1712086

Contact Information

Robert A. Jarrow (Contact Author)
Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )
Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)
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