The credit risk(+) model with general sector correlations

We consider an enhancement of the credit risk+ model to incorporate correlations between sectors. We model the sector default rates as linear combinations of a common set of independent variables that represent macro-economic variables or risk factors. We also derive the formula for exact VaR contributions at the obligor level.

Application of nonlinear filtering to credit risk

Merton's model views equity as a call option on the asset of the firm. Thus the asset is partially observed through the equity. Then using nonlinear filtering an explicit expression for likelihood ratio for underlying parameters in terms of the nonlinear filter is obtained. As the evolution of the filter itself depends on the parameters in question, this does not permit direct maximum likelihood estimation, but does pave the way for the `Expectation-Maximization' method for estimating parameters. (C) 2010 Elsevier B.V. All rights reserved.

New Ventures’ influence on the Growth of SME Employment, Production and Exports in India: Does Institutional Credit matter?

New ventures are considered to be a major source of small firm growth. In Indian context the contribution of new ventures in terms of new employment, production and exports has largely remained unexplored. It is equally important and unexplored, the significance of the contribution of bank credit to the growth of new ventures in India. This paper is an attempt to throw light on these two aspects. The research is based on secondary data of the liberalized period provided by Ministry of Micro, Small and Medium Enterprises, Government of India and Reserve Bank of India. To analyze the influence of bank credit growth on new ventures and the influence of new ventures on growth of additional employment, additional production and additional exports, we used a Bi-Variate Vector Auto Regression. Based on the model generated, Granger causality tests are conducted to obtain the results. The study found that rate of growth of bank credit causes the number of new ventures, implying any increase in the rate of growth of bank credit will be beneficial to the growth of new ventures. The study also concluded that new ventures are not causing the growth of additional employment or additional production. However new ventures cause the growth of additional exports. This is reasonable as entrepreneurs start their new ventures with minimum possible employment and relatively low rate of capacity utilization and they come up to take advantage of the process of globalization by catering to the international market.

Pricing credit derivatives

The financial crisis set off by the default of Lehman Brothers in 2008 leading to disastrous consequences for the global economy has focused attention on regulation and pricing issues related to credit derivatives. Credit risk refers to the potential losses that can arise due to the changes in the credit quality of financial instruments. These changes could be due to changes in the ratings, market price (spread) or default on contractual obligations. Credit derivatives are financial instruments designed to mitigate the adverse impact that may arise due to credit risks. However, they also allow the investors to take up purely speculative positions. In this article we provide a succinct introduction to the notions of credit risk, the credit derivatives market and describe some of the important credit derivative products. There are two approaches to pricing credit derivatives, namely the structural and the reduced form or intensity-based models. A crucial aspect of the modelling that we touch upon briefly in this article is the problem of calibration of these models. We hope to convey through this article the challenges that are inherent in credit risk modelling, the elegant mathematics and concepts that underlie some of the models and the importance of understanding the limitations of the models.

How to write a passable technical paper

In my job I see many students who have not learned to write a technical paper. When they do competent work, I want them to be able to write passable reports. This article is for them. There are well established principles for citing the relevant work of others; for not copying things without giving credit; for not stealing. If a reader feels you have copied anything, a figure, even a phrase, from elsewhere without citing its source, then you are guilty of plagiarism in the eyes of that reader. Committing plagiarism is so bad that I cannot do justice to it here. So I merely say: never do it. On, then, to writing your own honest and original material. Art requires talent. In contrast, through discipline and persistence alone, you can learn how to differentiate functions and ride bicycles. Similarly, you can write a passable technical paper. You just have to realize that your job does not end with research. Writing a passable paper involves extra work.

Optimal allocation of carbon credits to emitting agents in a carbon economy

Reduction of carbon emissions is of paramount importance in the context of global warming. Countries and global companies are now engaged in understanding systematic ways of achieving well defined emission targets. In fact, carbon credits have become significant and strategic instruments of finance for countries and global companies. In this paper, we formulate and suggest a solution to the carbon allocation problem, which involves determining a cost minimizing allocation of carbon credits among different emitting agents. We address this challenge in the context of a global company which is faced with the challenge of determining an allocation of carbon credit caps among its divisions in a cost effective way. The problem is formulated as a reverse auction problem where the company plays the role of a buyer or carbon planning authority and the different divisions within the company are the emitting agents that specify cost curves for carbon credit reductions. Two natural variants of the problem: (a) with unlimited budget and (b) with limited budget are considered. Suitable assumptions are made on the cost curves and in each of the two cases we show that the resulting problem formulation is a knapsack problem that can be solved optimally using a greedy heuristic. The solution of the allocation problem provides critical decision support to global companies engaged seriously in green programs.

Mechanism design problems in carbon economics

Reduction of carbon emissions is of paramount importance in the context of global warming and climate change. Countries and global companies are now engaged in understanding systematic ways of solving carbon economics problems, aimed ultimately at achieving well defined emission targets. This paper proposes mechanism design as an approach to solving carbon economics problems. The paper first introduces carbon economics issues in the world today and next focuses on carbon economics problems facing global industries. The paper identifies four problems faced by global industries: carbon credit allocation (CCA), carbon credit buying (CCB), carbon credit selling (CCS), and carbon credit exchange (CCE). It is argued that these problems are best addressed as mechanism design problems. The discipline of mechanism design is founded on game theory and is concerned with settings where a social planner faces the problem of aggregating the announced preferences of multiple agents into a collective decision, when the actual preferences are not known publicly. The paper provides an overview of mechanism design and presents the challenges involved in designing mechanisms with desirable properties. To illustrate the application of mechanism design in carbon economics,the paper describes in detail one specific problem, the carbon credit allocation problem.

Tamarind orchards: Agroforestry for dry lands

Agroforestry has a potential for sequestering as much carbon if not more than forests. Massive benefits can be channeled to small farmers and landless labourers through cultivation of Tamarind and other fast growing and fruit yielding trees. This paper describes a project started by small farmers and landless labourers in a semiarid areas of south India. The aim is to upgrade dryland holdings of the member families through economically sound dry land horticulture, community woodlots, and planting of fast growing species along orchard and field boundaries. The small farmers invest massive labour inputs and project gives economic benefits to change their land use practices and improve environmental quality. This paper describes the planning. processes of the project, hurdles in finding AIJ partners, current monitoring procedures and costs of C sequestration. This shows this project is economically viable on its own, but initially needed, and continues to need Carbon credit investment in order to spread rapidly across the geopolitical region covered by the organization. It argues that economic gains to small farmers and landless labourers are the most certain way of achieving massive biomass increase and soil carbon replenishment, and that multiple holistic benefits are achieved through this kind of project.

Pricing Defaultable Bonds in a Markov Modulated Market

We address the problem of pricing defaultable bonds in a Markov modulated market. Using Merton's structural approach we show that various types of defaultable bonds are combination of European type contingent claims. Thus pricing a defaultable bond is tantamount to pricing a contingent claim in a Markov modulated market. Since the market is incomplete, we use the method of quadratic hedging and minimal martingale measure to derive locally risk minimizing derivative prices, hedging strategies and the corresponding residual risks. The price of defaultable bonds are obtained as solutions to a system of PDEs with weak coupling subject to appropriate terminal and boundary conditions. We solve the system of PDEs numerically and carry out a numerical investigation for the defaultable bond prices. We compare their credit spreads with some of the existing models. We observe higher spreads in the Markov modulated market. We show how business cycles can be easily incorporated in the proposed framework. We demonstrate the impact on spreads of the inclusion of rare states that attempt to capture a tight liquidity situation. These states are characterized by low risk-free interest rate, high payout rate and high volatility.

IceCube: efficient targeted mining in data cubes

We address the problem of mining targeted association rules over multidimensional market-basket data. Here, each transaction has, in addition to the set of purchased items, ancillary dimension attributes associated with it. Based on these dimensions, transactions can be visualized as distributed over cells of an n-dimensional cube. In this framework, a targeted association rule is of the form {X -> Y} R, where R is a convex region in the cube and X. Y is a traditional association rule within region R. We first describe the TOARM algorithm, based on classical techniques, for identifying targeted association rules. Then, we discuss the concepts of bottom-up aggregation and cubing, leading to the CellUnion technique. This approach is further extended, using notions of cube-count interleaving and credit-based pruning, to derive the IceCube algorithm. Our experiments demonstrate that IceCube consistently provides the best execution time performance, especially for large and complex data cubes.

Strategic Marketing and Innovation Performance of Indian MSMEs

Micro Small and Medium Enterprises (MSMEs) is an integral part of the Indian industrial sector. The distinctive features of MSMEs are less capital investment and high labour absorption which has created unprecedented importance to this sector. As per the Development Commissioner of MSME, the sector has the credit of being the second highest in employment in India, which stands next to agricultural sector. The MSMEs are very much needed in efficiently allocating the enormous labour supply and scarce capital by implementing labour intensive production processes. Associated with this high growth rates, MSMEs are also facing a number of problems like sub-optimal scale of operation, technological obsolescence, supply chain inefficiencies, increasing domestic and global competition, fund shortages, change in manufacturing & marketing strategies, turbulent and uncertain market scenario. To survive with such issues and compete with large and global enterprises, MSMEs need to adopt innovative approaches in their regular business operations. Among the manufacturing sectors, we find that they are unable to focus themselves in the present competition. This paper presents a brief literature of work done in MSMEs, Innovation and Strategic marketing with reference to Indian manufacturing firms.