Filtering techniques in the modeling, pricing and hedging of interest rate and credit risk

• Applicants: Professor Dr. Rüdiger Frey; Professor Dr. Thorsten Schmidt
• Subject Area: Mathematics
• Term: from 2011 to 2015
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 196379142

In this project stochastic filtering methodology will be employed for solving pricing, hedging and calibration problems in interest rate and credit risk models. Stochastic filtering is concerned with the detection of signals from noisy observations. In interest rate and credit risk modeling, filtering problems arise naturally since important state variables such as firm values cannot be observed directly by investors. Existing filtering results are not yet sufficient for the application to complicated problems in model calibration and derivative pricing. The mathematical contribution of this project will therefore be the generalization of filtering results from the literature and the development of new numerical methods. On the financial side the project will contribute to a better understanding of dynamic credit risk models, including counterparty credit risk and credit contagion. Moreover, risk management techniques for derivatives such as dynamic hedging will be analyzed with the help of filtering. The practical relevance of these issues has been highlighted during the current financial crisis.

• DFG Programme: Research Grants
• International Connection: Austria