CONTENTS vii
6 Idiosyncratic Risk, Systematic Risk and Stochastic
Volatility: An Implementation of Merton’s Credit
Risk Valuation 107
Hayette Gatfaoui
6.1 Introduction 107
6.2 The general model 110
6.3 A stochastic volatility model 114
6.4 Simulation study 118
6.5 Conclusion 126
7 A Comparative Analysis of Dependence
Levels in Intensity-Based and Merton-Style
Credit Risk Models 132
Jean-David Fermanian and Mohammed Sbai
7.1 Introduction 132
7.2 Merton-style models 133
7.3 Intensity-based models 136
7.4 Comparisons between some dependence indicators 139
7.5 Extensions of the basic intensity-based model 143
7.6 Conclusion 150
8 The Modeling of Weather Derivative Portfolio Risk 156
Stephen Jewson
8.1 Introduction 156
8.2 What are weather derivatives? 157
8.3 Defining risk for weather derivative portfolios 159
8.4 Basic methods for estimating the risk in weather
derivative portfolios 160
8.5 The incorporation of sampling error in simulations 162
8.6 Accurate estimation of the correlation matrix 162
8.7 Dealing with non-normality 163
8.8 Estimating model error 164
8.9 Incorporating hedging constraints 165
8.10 Consistency between the valuation of single
contracts and portfolios 166
8.11 Estimating sampling error 167
8.12 Estimating VaR 167
8.13 Conclusion 168
