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MITOCW | watch?v=D2Jn1VrqjWI The following content is provided under a Creative Commons license. Your support will help MIT OpenCourseWare continue to offer high quality educational resources for free. To make a donation or view additional materials from hundreds of MIT courses, visit MIT OpenCourseWare at ocw.mit.edu. DENIS GOROKHOV: So I work at Morgan Stanley. I ran corporate treasury strategies at Morgan Stanley. So corporate treasury is the business unit that is responsible for insuring and risk management of Morgan Stanley debt. around their strategists own the New York inflation desk. That's the business which is a part of the global interest rate business, which is responsible for trading derivatives linked to inflation. And today, I'm going to talk about the HJM model. So HJM model-- the abbreviation stands for Heath-Jarrow-Morton, these three individuals who discovered this framework in the [INAUDIBLE]. And this is a very general framework for pricing, derivatives to interest rates, and to credit. So on Wall Street, big banks make a substantial amount of money by trading all kinds of things-- exotic products, exotic derivatives. And big banks like Morgan Stanley, like Goldman, JP Morgan-- trades thousands and thousands of different types of exotic derivatives. So a typical program which the business faces is that new types of derivatives arrive all the time. So you need to be able to respond quickly to the demand from the clients. And you need to be able not just to tell the prices derivative. You need to be able also to risk manage this derivative. Because let's say if you sold an option, you've got some premium. If something goes more in your favor, you need to pay in the end. So you need to be able to hedge. And you can think about the HJM model, like this kind of framework, as something which is similar to theoretical physics in a way, right? So you get beautiful models-- it's like a solvable model. For example, let's say the hydrogen atom in quantum mechanics. 1
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So it's relatively straightforward to solve it, right? So we have an equation, which can be exactly solved. And we can find energy levels and understand this fairly quickly. But if you start going into more complex problems-- for example, you add one more electron and you have a helium atom-- it's already much more complicated. And then if you have complicated atoms or even molecules, it's unclear what to do. So people came up with approximate that kind of method, which allow nevertheless solve like very accurately numerically. And HJM is a similar framework. So you can-- it allows to price all kinds of [INAUDIBLE] derivatives. And so it's very general. It's very flexible to incorporate new payoffs, all kinds of correlation between products and so on, so forth.
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  • Spring '17
  • Jim Angel

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