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Commodity swap?

2 messages · Christofer Bogaso, Brian G. Peterson

Original
Christofer Bogaso
# 
unlike most interest rate swaps explained in common risk management book, I
found that in most of the exchanges like IPE etc, cash flow is generally
happen daily (where for interest rate case it is mostly monthly or quarterly
etc) and all of the case underlying is some futures contracts. 

In ordinary ineterst rate case future expectation is generally replaced by
the futures quote. Therefore my question is, if swap is based on futures
itself then how can I get unbaised expected value as proxy?

Or should I treat this kind of swap contract just like a Basis wherein Basis
= (tomorrow's future quote - fixed) and try to understand the tomorrow's
possible distribution that future quote and hence the VaR just the same way
as Delta-normal approach?

What I mean is that :

VaR in this approach :

5th worst of (Basis[t+1] - Basis[t]) = (Futures[t+1] - Futures[t]), as other
leg is fixed and therefore no risk is there.

Is it the currect? Then how should I incorporate term structure which is
generally the case for interest rate swap?

If somebody can give some view, it would be great. 

Thanks,
Brian G. Peterson
#
Bogaso wrote:
Christofer,

Every swap contract is different, and you didn't actually tell us what contract 
you're looking at.  So replies will of necessity be somewhat more general than 
your general questions...

Considering a futures contract to be an 'unbiased expected value as proxy' is a 
bit of a stretch in any event.  Futures, like any other financial instrument, 
exhibit all sorts of biases and market forces. All that aside, you're on the 
right track.

The risk of *any* swap is the risk of the underlying basket portfolio.

Given that you can model a swap as a basket portfolio, you are correct that you 
would model the risk of the underlying futures contract.  However, I don't 
understand why you are thinking about one-day risk as opposed to some longer 
time horizon.  In some frameworks (e.g. Basel II, or a day trading firm) daily 
risk is required, but in many investment frameworks, you're most concerned with 
longer time horizons, even if the contract is valued daily.  It is of course 
straightforward to aggregate prices or returns to a longer horizon.  (using 
to.period in xts for price series or PerformanceAnalytics' portfolio return 
functions for return series in R)

You would model the term structure using any of the many tools available in R 
to do so (termstruct comes immediately to mind, though there are many other 
models represented in other packages). This would enable you to add interest 
rate basis risk to your market risk estimates.

Any complex synthetic instrument may be modeled as though it were a portfolio 
of the underlying or representative assets.  What you choose as your risk 
measure (Expected Shortfall, Delta-VaR, Conditional expectation of Drawdown, 
etc.) is, as always, a business decision based on your investment style and 
time horizon.

Regards,

    - Brian