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Report

Teaser, summary, work performed and final results

Periodic Reporting for period 2 - WAKEUPCALL (Applied mathematics for risk measures in finance and insurance, in the wake of the crisis)

Teaser

Summary

The EID WAKEUPCALL has been set up with the knowledge that, in the wake of the financial crisis, a reconsideration of fundamental assumptions that have been standard in the mathematical models for the valuation of financial and insurance products is taking place. The crisis alerted to reiterate models, assumptions, analysis and computations. It is now better understood that the usual paradigm, in which financial risks can be mitigated, spread, or even hedged away perfectly, is too simplistic for markets under stressed conditions. Lead by the Basel Committee on Banking Supervision, the financial and insurance industry is currently implementing new paradigms regarding risk management. Many of the updates in the risk measures involve sophisticated mathematics. In this sense, the crisis has provided important feedback on appropriate directions for the required mathematical improvements. As regards to hedging and risk mitigation, which are important steps in the risk management chain, nowadays even the hedging of basic financial instruments has become a complicated task. Since the 2008 crisis, the historically stable relationship between a bank\'s funding rate, government rates, and inter-bank offered rates is no longer valid, which can be explained by credit risk, liquidity risk, and related bid-ask spreads. More sophisticated models are needed if hedging programs are to remain effective under financial stress, but then also model risk needs to be taken into account. A good understanding of financial risks in the modern world is important for society.

The overall objective is to perform multi-disciplinary research and gain insight into a variety of aspects of financial risk, such as model risk, market risk, and credit risk. Each industrial partner focusses with an ESR on a specific risk which is important in their businesses. From the various ESR projects, the ESRs will gain expertise on risk measures and risk management for modern financial mathematical models, on computing algorithms, software, frameworks, and also consultancy expertise will result. The ESRs will have an excellent background to obtain a high level job in the industry afterwards.

Work performed

\"With the 6 ESRs we have worked on several work packages (depending on the specific ESR project). Most extensively, research work has taken place in WP1 \"\"Modelling\"\".
All ESRS have defined their respective models for their specific task in post-crisis risk management. A number of research papers has evolved for the work in this WP;
they are currently under review by editorial boards of respected international journals.
We are on schedule regarding the general original planning of the project.
ESR1, in Spain, started with fundamental theoretical research into the robustness of modern risk measures, resulting in the paper \"\"Risk Estimation under Probabilistic Symmetries\"\", which has been sent to a highly respected journal for review. In the second project at the Spanish project partners a fundamental new view at \"\"Model Risk in Banks\"\" is given, in an intensive collaboration with top researchers at Banco Santander (with ESR2).
ESR3 works, in Bologna, on default risk models, and in particular at the impact of jumps in the stochastic processes related to default.
ESR4, also in Bologna, placed Counterparty Credit Risk quantitative computations successfully within the mathematical framework of Backward Stochastic Differential Equations (BSDEs).
ESR5, in the Netherlands, also worked on BSDEs, employed wavelets for the robust and efficient computations, as well as a special Monte Carlo method. The latter work is currently implemented to run on a parallel machine.
Finally, important findings by ESR6, in the Netherlands, include a new risk measure beyond the Value at Risk and Expected Shortfall (ESR6) (the technical report was a top download at SSRN, Social Sciences Research Network).\"

Final results

\"The hard work and intensive collaboration with the industrial partners has resulted in progress that is, to the coordinator\'s opinion, beyond the usual progress after one year of PhD research.
We have several papers, some already with very positive referee reports, and truly state-of-the-art research. This is beneficial for the stakeholders, but also EID-WAKEUPCALL seems to be
an EID project how the EID framework is meant to be. Especially the close interaction between academics and industry is impressive.

Outstanding additional achievements, include the thorough education in the computer language Python, as this is becoming popular and important at financial institutions nowadays.
On the explicit feedback of the ESRs, we have added another educational module on Python in this context (the parallel Python course in Delft in October 2016).
The general high quality workshops that have been defined in the context of WAKEUPCALL in Bologna and A Coruna, with many participants from other EU projects and also
from other countries.

As a final example of \"\"extras\"\", on the specific demand of the ESR, we mention the secondment of ESR4, Anastasia Borovykh, in CWI, where she wanted to learn about data driven research and machine learning.
This has resulted in a impressive gain in knowledge in this new topic (not in the original project plan), and even in a research paper that will be submitted to a conference in this field.

More generally, the progress of the ESRs, as seen in their presentations at the Mid-Term Review and at other meetings, is beyond our expectations.\"