Twofish's Blog

July 30, 2006

Interest rate derivatives and the third lever

Filed under: china, quantitative finance, quantlib — twofish @ 11:25 am

One more post, and I’ll start to do real work.  I’m in the process of reading Modern Pricing of Interest Rate Derivatives by Rebonato, and this is turning out to be much more useful than I thought it would be.  The PRC market doesn’t have much in the form of Interest rate derivatives, (some swaps in the interbank market) so there isn’t a demand for quants that can calculate these things.

What I’m wondering is that how interest rate derivatives work with the “third lever.”  Western economies are controlled by two levers, fiscal policy, and monetary policy.  The Chinese economy is controlled largely by the “third lever” which are government directives that directly order “macroeconomic adjustment.”  The recent flurry of adminstrative orders on the real estate market is an example of the “third lever” in action.

So one thing I’ll be thinking about is how interest rate derivatives should/do interact with the third lever.  This involves getting deeper into macroeconomics than most quants, and at that point my tendency toward “Austrian models” will probably come in useful.  The problem with most macroeconomic such as the “neoclassical synthesis” and the “Keynesian model” is that they assume that the economy is already structured in a certain way, which means that they are useless if the economies *isn’t* structured that way or if they question on the table is how the economic *should* be structured.  So if the main control over the Chinese economy is this “third lever” then its hard to understand how this works from a non-Austrian viewpoint.

The cool thing about Austrian economics is that Austrian economics starts basically from the viewpoint of basic human desire.  You look at the individual, see what they want, and then how individuals interact with each other, and then you build your models from this.  This means that the fact that the Chinese economy could/should work completely differently as no bar to using analysis via Austrian models.

The other thing that I could work on is trying to get jump models into the interest rate market models, and try to figure out how all of this works with convertible bonds.

Anyway let me stop blogging and just do that….


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