Monte Carlo Var on corporate bonds

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Simon Vasco
Posts: 1
Joined: Tue Jun 11, 2013 9:09 am

Monte Carlo Var on corporate bonds

Postby Simon Vasco » Tue Jun 11, 2013 1:26 pm

Hi Carol,

I wanted to run a Monte Carlo Var on a portfolio of corporate bonds but was unclear as to the standard practice for deriving volatility and correlation numbers - i.e. what historical data does one use to calculate the volatility and correlation that are inputs to the Monte Carlo model. I can think of 3 ways to proceed but none of them seem entirely satisfactory. I wondered what your preferred route was?

1) Although one could use historical single name bond data (with some sort of duration adjustment) this would present a problem for recently issued bonds with little data.

2) Using single name CDS data (where available) would mean there was sufficient data but one would not easily be able to capture the cds-bond basis effect in the model (which can be significant).

3) Using generic proxies (e.g. a bond index) and adjusting as necessary for spread and duration. This would be fairly straightforward to implement but would tend to miss idiosyncratic behaviour and would not capture the basis effect for very high spread names.

Simon Vasco

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