Abstract
To study arbitrage-free pricing, we start with a simple financial market containing two instruments, a money-market account instrument (in some literature referred as a bond) B and another security S. The other security can be a stock (equity) or some kind of derivative, such as an option. We want to study a portfolio (B, S) today (at time t = 0) and at a future time t. The money-market account has the following simple property. This means that the value of the money-market account instrument today is 1 (in some currency) and at the future time t, the value is given by 1 + r, where r is the risk-free interest rate . This interest rate will be discussed in more detail later. An important property of the money-market account is that the interest rate is the same for borrowing as for lending.
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Notes
- 1.
This is only an abstract representation of the situation with two events that might be true in the future.
- 2.
This is to simplify the calculations. If the loans default independently of each other so that two defaults can occur, the numbers are very slightly different, but the VaR of the portfolio is still greater than the sum of the VaRs of the individual loans.
- 3.
Sometimes CVaR is the acronym for Credit VaR.
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Röman, J.R.M. (2017). Time-Discrete Models. In: Analytical Finance: Volume I. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-34027-2_2
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DOI: https://doi.org/10.1007/978-3-319-34027-2_2
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Publisher Name: Palgrave Macmillan, Cham
Print ISBN: 978-3-319-34026-5
Online ISBN: 978-3-319-34027-2
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