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An immediate, fundamental change in thinking is required to take the panic out of the Contingent Convertible/AT1 Bond market, Philippe Henrotte tells Wilmott.
Farhad Firouzi, quantitative analyst, and Elie Ayache, co-founder and chief executive officer of ITO33, present a fast and accurate method of evaluating one of the most daunting features of the convertible bond market - convertible bonds with the soft call feature of 20 out of 30 days.
Local volatility was, for a long time, seen as being a universal panacea. However, cracks appeared and we have been forced to look elsewhere for a new framework.
A convertible bond holder is short dividend. When a dividend is paid, the underlying share drops by a fraction of this dividend.
““Elie Ayache pulls off the philosopher’s mask and reveals himself to be the … well, I won’t spoil the surprise. What our good friend Ayache does do, I can reveal, is take on implied volatility just one last time in an epic article worthy of a good stiff drink and absolute silence…” (Paul Wilmott, from the Ed’s Letter).”
The local volatility model helped give birth to a liquid equity variance swap market. But, Philippe Henrotte writes, the ungrateful child has now matured and is about to terminate its creator …
Learn how Irony always supersedes Theory in derivative pricing, according to Elie Ayache.
Elie Ayache traces how convertible bond pricing went from a specialist niche to a new paradigm in volatility arbitrage.
““Out-of-model risk results from the empirical recognition that no model is immune to internally inconsistent re-calibration,” Philippe Henrotte writes.”
““Implied Volatility is not just a word or a concept,” Elie Ayache writes.”
Calibration, recalibration and co-calibration. These, according to ITO33, are the keys to unlocking the problem of derivative pricing.
A return to issues raised by an article published in January last year.
Elie Ayache explains why the regime-switching model answers the challenges of re-calibration and co-calibration in the equity-to-credit problem.
Vadim Zeitlin explains why it may be interesting to provide the users of C++ pricing libraries with the possibility to call them from any language of their choice.
““Departure from time homogeneity may be the sign of serious modelling deficiency,” writes Philippe Henrotte. With three important examples, Philippe shows that it is possible to calibrate parsimonious time homogeneous models to complex term structures. His examples include the volatility smile, the credit spread, and the yield curve.”
Elie Ayache, Philippe Henrotte, Sonia Nassar and Xuewen Wang address the problem of smile dynamics and how it can be solved.
In a finite element framework, Nabil Ouachani and Yunzhi Zhang analyze the pricing of cross-currency convertible bonds where the underlying share is denominated in a currency foreign to the convertible bond issue.
Yann d’Halluin and David Pooley propose robust and efficient techniques for the numerical solution of option pricing models where the underlying process is a jump diffusion process.
Toufic Abboud and Yunzhi Zhang present a numerical method for computing the free boundary problem for the American Put.
Elie Ayache, Peter Forsyth and Ken Vetzal examine the impact of default and of several recovery assumptions on the pricing of convertible bonds in reduced-form credit risk models.
We recognize in Black– Scholes–Merton the ‘model of a carpenter’, and we seek ways how truthfully to generalize it.
Two fundamental concepts of Bergomi’s, the trading decision and the pricing function, turn probability merely into an interpretation.
A thorough reading of Bergomi sheds new perspectives on rough volatility in relation to the meaning of the options market.
Black-Scholes-Merton was never equipped to face an options market. The formula doesn’t know what an options market is and even less so what the meaning of inverting the formula and implying volatility from the option market price could possibly be.
No statistics can represent the abyss of the event. Only the market can, provided the story is told right.
What is the smile problem? How can it be interpreted? Do people really understand it?
Dan Tudball discusses the consequences of inverting our thinking about the market with Elie Ayache.
Financial pricing, in its usage of the term ‘real probability’, has not managed to unshackle itself completely from actuarial valuation. Even though the market of contingent claims is the long-awaited technology that would finally allow us to account for the future contingent events without using probability…
Not only does the market not need probability, the market replaces probability.
Elie Ayache explains why you must always think outside the box, yet keep the box with you at all times.
The capacity of writing provides the missing link between the Kerviel case and the credit meltdown argues Elie Ayache.
‘Necessity of the Future. Elie Ayache: From the Hume-event to the 1987-event, through Cantor and Badiou.’
Necessity of Contingency. As a fresh (and French) theorist of speculation, Elie Ayache combines a French president and a young French philosopher.
Credit led to the “disappearance” of the market; Elie Ayache ponders how we should make preparations for its return.
The best way to predict the Black Swan is to write it, claims Elie Ayache. In other words, to replicate it, to trade it, to exchange it. This is why his Black Swan is set against Taleb’s, and in a way, written all over (against) it.
The best way to predict the Black Swan is to write it, claims Elie Ayache. In other words, to replicate it, to trade it, to exchange it. This is why his Black Swan is set against Taleb’s, and in a way, written all over (against) it.
Elie Ayache contends that dynamic replication is the “inaugural event” of derivatives markets. Ayache continues his theme and shows how the October 1987 crash can be seen as the “other” beginning of derivatives markets. Both beginnings (the first and the other) are required in order to address the question of the next technology for derivatives markets.
Elie Ayache contends that dynamic replication is the “inaugural event” of derivatives markets. Ayache continues his theme and shows how the October 1987 crash can be seen as the “other” beginning of derivatives markets. Both beginnings (the first and the other) are required in order to address the question of the next technology for derivatives markets.
Learn how Capacity, not Possibility or Probability, is the dynamic trader’s main virtue, according to Elie Ayache, and how derivatives markets are the technology of the future.
Learn how the philosophy of Jacques Derrida can provide the “non-foundation” of the founding paradox of derivative pricing, according to Elie Ayache.
Elie Ayache proposes that the market is a new “epoch” of Being.
Elie Ayache proposes that the market is a new “epoch” of Being.
Uncovering a broader view of probability by taking a lead from Quantitative Finance.
Elie Ayache takes a step beyond essential uncertainty to tie up a few loose ends.
The concluding part of the discussion on a new view on quantitative finance.
Introducing a new voice in option language and the central question all quants need to ask.
““Why should we write about smile models?” asks Elie Ayache. “This is the question behind the question. For if the definitive smile model is not yet in sight, perhaps a definitive smile story is possible.””
““Why should we write about smile models?” asks Elie Ayache. “This is the question behind the question. For if the definitive smile model is not yet in sight, perhaps a definitive smile story is possible.””
ITO33’s Opscore Web Service delivers easy, cutting-edge engagement with the convertible bonds market for non-specialists.
‘Elie Ayache : “Le trading des produits dérivés n’a rien à voir avec les distributions de probabilité” Il fut un des premiers traders de volatilité sur le matif ! Fondateur d’ITO33 et ancien responsable de la recherche à Dexia AM, Elie Ayache nous livre sa réflexion sur les Marchés dérivés qu’il définit comme la technologie du futur…’
We speak to Elie Ayache at ITO33, who dissects various layers of complexity in Asian Convertible Bonds and ASCOT and sheds light on their popularity.
Learn how this strongly path-dependent asset is alive and kicking at ITO33.
Elie Ayache discusses his forthcoming regular column with Dan Tudball exploring the need for a philisophical foundation in quantative finance.
The Blank Swan is available for purchase on Amazon, Google, Barnes and Noble and Wiley, among others.
This book is packed with philosophy and if you don’t handle it with care it will explode in your hands. If you open it properly, however, you will find an explosion of meaning in every sentence and every word and a constant challenge for thought. Some say its writing style is difficult, which is true, no doubt. I am not here, indeed, to cajole the reader, and least of all, to condescend to vulgarize my topic.
Throughout its writing, I was guided solely by the thought of the market – a thought, as you will all agree, that is compelled to diverge and to constantly break out, lest the sequence converges and the market comes to a halt. I haven’t been interested by the domains but by their limits, and beyond their limits, by inverting the domains. I have travelled the logic of derivative pricing to its end, tracing this journey in my book, and found no final passage to the market but in inverting the traditional order of thought and in placing price before probability and absolute contingency before possibility. The result is a reconstruction of the market of contingent claims in the realm of writing and difference instead of identity and delimitation of states.
Both in the philosophical argument and in the writing strategy, I have avoided every naivety in thought and every comforting station, finding the disappearance of the market as the last contingency that it is necessary to think, especially in these days. This is the moment when the book, as a binder, and the market, as a domain, can no longer contain thought and when their non naive recovery requires a total revolution. One in which the metaphysics of the market becomes the market as metaphysics and the interior of the book becomes the world inverted.
Elie Ayache
“I am relieved to finally find a book that deals with Black Swan Events in a new way. Ayache brings a reverse-probabilistic perspective … so, view this as a gutsy look at the ’end of probability’ and how we will need to envision the world once we get rid of this artificial, antiquated tool. I am also glad to see that those of us trained in the trading of options can have views original enough to influence the philosophy of probability and the philosophical understanding of contingency.”
Nassim Nicholas Taleb, author of The Black Swan
We consider thought under its two indissociable aspects, concept and intuition. You can only expand the concept by analysis, and fail to synthesize objects, in Kant’s sense of objects of possible experience. For that purpose, something must be added to the concept, which is intuition. Concepts without intuition are empty, according to Kant.
Probability theory is a theory of the concrete world, as such indissociable from possible experience. For this reason, there is something more in probability theory than in real analysis. It is the concrete situation, or trial of the world, or random sample ω, without which probability theory would lack the two characteristic notions of independence and repetition. The trial ω is the Kantian intuition of probability theory. The event A, which alone is subject to analysis and is assigned probability, thus admits the concrete situation ω as content (ω ϵ A).
Under the concepts of probability theory, the Black-Scholes-Merton (BSM) analysis leads only to the dynamic replication of contingent payoffs, and to no market thereof. To change constant volatility into stochastic volatility does not help. In order to exist, the derivatives market requires a new form of Kantian sensibility and the corresponding intuition, or concrete situation, which we denote by ϖ. The situation ϖ of the market is radically different from the situation ω of probability theory or statistical analysis. Implied volatility is logically (even temporally) incompatible with historical volatility.
The specific intuition of the market ,ϖ, is the “exchange”. As Helyette Geman says: “BSM is risky by definition because it amounts to exchanging volatility.” As a result, BSM must be thought differently. It becomes the first instance of the “market models”, whose conceptual analysis relies on the “trading decision” and the “pricing function”, or the very denial of probability and stochastic structure.
Recent propositions in derivative pricing and stochastic volatility modelling suggest that truth exists below the surface of derivative and asset prices, truth as seen from God’s point of view, and that this final truth is the rough volatility model. By contrast, the market models approach (e.g. Bergomi) finds no place for such underlying truth, or indeed underlying stochastic process, and believes only in surface models, where derivatives are themselves the underliers and their price is the only fact, produced solely by the machinic, automatic, autonomous and anonymous logic of the market.
We attempt to strike the right balance between these two extremes, and to find the only truthful derivative pricing model, neither God’s nor the machine’s: what we call Man’s model.
A ‘contingent claim’ is another term for a financial derivative with a payout dependent on the realization of some future contingent event. In turn, the future prices of these contingent claims become new future events on which further contingent claims are written. When ‘The Market’ is defined as this endless material chain, argued Elie Ayache, time drops out of the equation and the future, literally, is no longer ahead.
Elie Ayache
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