Current and Planned Activities

Standardisation

Calculating the Liquid Eurozone Government Curve…

The Bond Commission is also working on finalisation of standards for a methodology of calculating the Eurozone liquid government benchmark curve (i.e. the default-risk free curve which is at the root of numerous pricing models. This project is of particular interest to various European authorities (eg ECB, EIB), because a standardised and simple methodology that is purely objective and formula based, and comes from an independent third party would add transparency to both the Eurozone government bond market and the Eurozone credit market.

Credit Derivatives

The Bond commission recently formed a working party to investigate the potential to standardise a valuation methodology for credit derivatives. In the past the Bond Commission has noted that there is often an evolution from an opaque and little known instrument to an extremely transparent and extremely liquid instrument: the swap market is a classic instance. In this move a certain amount of standardisation has to take place, usually first of all on the legal side, to make paper work simpler. When it comes to standardising methodologies for calculations of this kind, market leaders often all have their own way of calculating key parameters, which are likely to be all very similar to each other, but different enough to give slightly different results. None of these will want to give way to any other but what the Commission has noticed is that the EFFAS-EBC was looked upon as neutral arbiter capable of synthesising differences. If possible the Commission would like to achieve such a consensus for credit derivatives.

Research

Fitting Yield curves through Missing Data Points

As an overlay, Sergey Smirnov has been applying our yield curve methodology not only to credit product, but also to government product where there is missing data. In other words: if you have a government bond market where bonds don’t necessary trade every day, but you do want a relatively stable and robust curve, you have to find a way to fill in the missing data points, while maintaining a robust curve with minimal volatility. Sergey Smirnov has created an algorithm that is both robust and practical, likely to be of great practical use in numerous contexts.

Book Projects

Omega

One book project concerns the Omega function, a statistical tool developed by Con Keating, the ex-chairman of the Methods and Measures Committee (a sub committee of the EEBC), together with a number of mathematicians. Omega (3Mb) 

The Euro and The Accessor Nations

Another book project is the publishing of the book about the Euro, this time on “The Euro and The Accessor Nations” covering among other aspects, the economics of Eurozone expansion; institutional, legal and accounting issues of Eurozone Expansion; the process of adopting the Euro for the new members (which is of great interest for both Eurozone members, and international investors); and of course, the effect on Financial Markets. As with the previous 3 books in a series based on the single currency, the book will be written and edited by Paul Temperton and will consist of a number of contributions from different experts in different fields covering that whole range.

Index Book

The 2nd edition of “Constructing and Calculating Bond Indices” has been published in 2002. We are now planning a 3rd edition. The first edition has essentially covered government bonds; the second edition widened the scope to include credit. This project is self-financing through sponsorship. The publication is paid for before it is printed, and therefore involves no financial risk. Accumulated profits are used from time to time to finance various forms of research, including pure research at a university PhD students level or higher.

For the 3rd edition of the “Constructing and Calculating Bond Indices” the Bond Commission wants to incorporate research that the commission has financed. The research is into the possibility of developing a rules-based sector classification for bonds within indices. There is a great demand for such rules from both index-providers and index-users. We cannot simply map from the equity world to the bond world for two reasons: first, a vast number of bonds have no equity related to them whatsoever (or are government agencies, EIB etc), and, second, within the same issuer it may well be inappropriate to put different bonds from the same issuer into the same sector. To assume that extremely senior ranked collateralised insured bank bonds are somehow in the same sector as super subordinated bonds issued by the same bank is not ideal. The first stage of this research was to decide whether there was a phenomenon to observe or whether sectors were just imaginary phenomenon. The first study has established econometric evidence of clustering. The Bond Commission is now at a second stage which is to identify the most static factors in clustering. The final goal is to produce a rules-based system for unequivocal identification of index sector for any bond, based simply on its description, terms and characteristics. Its terms and conditions would then be enough to identify the correct sector classification.

Sponsored Research

OECD Global Pension Fund Project

Another project is a co-sponsorship of a privileged partnership position with the Organisation for Economic Co-operation and Development (OECD) on Global Pensions Statistics Project. OECD has been trying to organise a taxonomy of assets and liabilities within the pension fund world. Beyond this they want to gather the statistics on a regular basis, ideally from all their members in order to provide historical data for policy makers, investors, etc in a more granular format than it is possibly available today. Some of the preliminary results of their first set of statistic were for example information that apparently Dutch Pension Funds own quite a few bonds, but no government bonds. The Bond Commission was able to raise a finger at this one suggesting that this might be wrong. The involvement of the Bond Commission is highly appreciated in this project due to their sound knowledge of the markets.