# Newsletter of the Bachelier Finance Society

## Volume 9, Number 2, April 2017

**JOB POSTINGS**

The aim of these postings is to create a forum for the dissemination of information on academic and industrial positions related to mathematical finance, across different disciplines and different geographical regions. Please submit any job advertisements you are aware of to jobads@bachelierfinance.org, preferably in plain text and sending the link to the website containing all the information. Updates and new items appear continuously at: http://www.bachelierfinance.org/forum/jobs/.

**Associate Professor/Senior Lecturer/Lecturer**

University of Melbourne

Deadline: April 23, 2017

**Research Group Leader**

University of Vienna

Deadline: April 30, 2017

**2 Lecturers and Associate Professor/Senior Lecturer**

University of Auckland

Deadline: May 8, 2017

**Postdoc/Visiting Assistant Professor**

University of California Santa Barbara

Deadline: June 30, 2017

**Assistant Professor**

Stony Brook University

Deadline: September 8, 2017

**Postdoctoral position**

Boston University

**BOOKS & JOURNALS**

The Society maintains a list of books, book reviews and journals at: http://www.bachelierfinance.org/publications.html. Members that would like to have their books added to the website, should please let us know.

#### Recently published books

John Armstrong

**C++ for Financial Mathematics**

Chapman & Hall/CRC (2016), ISBN 9781498750059

René Carmona

**Lectures on BSDEs, Stochastic Control, and Stochastic Differential Games with Financial Applications**

SIAM Series on Financial Mathematics (2016), ISBN 9781611974232

Kathrin Glau, Zorana Grbac, Matthias Scherer, Rudi Zagst (Eds.)

**Innovations in Derivatives Markets: Fixed Income Modeling, Valuation Adjustments, Risk Management, and Regulation**

Springer Verlag (2016), ISBN 978-3-319-33445-5

Olivier Gueant

**The Financial Mathematics of Market Liquidity: From Optimal Execution to Market Making**

Chapman & Hall/CRC (2016), ISBN 9781498725477

Jan Kallsen, Antonis Papapantoleon (Eds.)

**Advanced Modelling in Mathematical Finance: In Honour of Ernst Eberlein**

Springer Verlag (2016), ISBN 978-3-319-45873-1

Paolo Sironi

**FinTech Innovation**

John Wiley & Sons, Inc. (2016), ISBN-13: 9781119226987

#### New journal

**High Frequency
**High Frequency is an interdisciplinary journal devoted to the theory, analysis, and practice of high-frequency data questions. Editors-in-Chief: Ionut Florescu & Frederi Viens. Published by Wiley.

### ANNOUNCEMENTS

**Call for papers** associated to the 3rd Symposium on Quantitative Finance and Risk Analysis (QFRA 2017, http://www.liv.ac.uk/qfra, Corfu, Greece, June 15-16, 2017).

- Annals of Operations Research (Springer) will publish a special conference issue on papers dedicated to "Application of Operations Research to Financial Markets".
- China Finance Review International (Emerald Journals) will publish a special conference issue on papers dedicated to "Modern Aspects of Financial Engineering".
- ASCE-ASME Journal of Risk and Uncertainty in Engineering Systems (ASCE Library) will publish a special conference issue on papers dedicated to "Community Resilience Economics".

The deadline for all submissions is October 31, 2017.

### BOOK REVIEW

## Hedging with Coconut Trees

#### A review of *Brazilian Derivatives and Securities*,

by Marcos Carreira and Richard Brostowicz,

Palgrave Macmillan, 2016.

#### Matheus R. Grasselli, McMaster University

“Brazil is not a simple country”, warn the two personable authors in their opening sentence, “. . . yet it is a fascinating country”. The same is certainly true for this demanding yet fascinating book. Carreira and Brostowicz have written a *sui generis* exposition of Brazilian interest rate (IR) and foreign exchange (FX) derivatives and securities with all the flavour and sway of my home country. The humorous style runs from the start (“If you see a turtle on top of a post, you wonder: ‘Who put it there?’. Well, in this book there are some turtles not only sitting on top of posts, but they’re juggling chainsaws as well”, page 1) to the end (“Brazil being Brazil, the only thing we can be sure about is that we cannot be sure about anything else”, page 297) of the book, alongside a mixture of historical accounts, institutional details, mathematical derivations, deep financial insight, and the kind of trader’s talk that give a headspin to non-market types like myself.

Chapter 1 sets the tone for the book by offering a breakneck-speed overview of financial markets in Brazil over the last 50 years. Here we see the Selic rate (short for “Sistema Especial de Liquidação e Custódia”, the Brazilian analogue of the Fed funds market, with the corresponding Fed funds rate) shoot up to almost 800,000% per year in 1990, or the CDI rate (“Certificado de Depósito Interbancário”, the Brazilian analogue of a LIBOR rate) hover around 2% per day around the same period. We learn about the all-important COPOM meetings (“Comitê de Polı́tica Monetária”, the Brazilian analogue of the Fed’s FOMC meetings) and their role in setting monetary policy through the SETA rate (“Selic Target”, the equivalent of the Fed funds target rate). The extraordinary behaviour of interest rates is matched by bouts of currency devaluation so severe that the rollercoaster graphs for the exchange rate only make sense in logarithmic scale. It is clear after reading the chapter that the behaviour of interest and exchange rates in Brazil is overwhelmingly influenced by what Peter Carr calls “events” in the book’s Foreword, precisely the types of jumps that are largely neglected by mainstream mathematical finance. And the mother of all events was without a doubt the Plano Real, the inflation fighting measures enacted by President Fernando Henrique Cardoso in 1994, which marks a regime change clearly identifiable with naked eyes in all graphs in this chapter.

Chapter 2 is a more sedate overview of several market conventions in Brazil, including calendars (an important issue in a country with a record number of public holidays) and different reference rates, or “fixings”. The aforementioned Selic, CDI, and SETA rates are explained in more details, together with some other less relevant interest rates. Two important inflation indices are introduced in this chapter: the IPCA (“Índice Nacional de Preços ao Consumidor”), a consumer price index published by IBGE, a government statistical agency, and used by COPOM for inflation targeting and many inflation-linked government bonds, and the IGPM (“Índice Geral de Preços de Mercado”), a more volatile price index published by FGV - Fundação Getúlio Vargas, a renowned private think-tank named after a statist president (oh the contradictions!). The chapter ends with a discussion on references for exchange rate, most importantly the PTAX, a weighted average of BRL/USD spot rates provided to the Central Bank by FX dealers for trades occurring at predetermined times throughout the day, and some alternatives when the PTAX rate is not available or suitable for certain derivatives.

Chapters 3 and 4 provide an in-depth exploration of the most liquid and important IR derivative in Brazil: the DI future, namely a future contract on the CDI rate mentioned above (think of it as a Brazilian LIBOR). Just as with any future contract, a long position in a DI future is a bet that its price will move up, and consequently, because of the inverse relationship between prices and rates expressed in equations (38)-(39) in the book, that CDI rates will move down in future. These are the contracts used to obtain the CDI term structure curve, which is prevalent not only in derivatives markets in Brazil, but also used in a large array of loans for the real economy, so the authors cover in detail the pricing of DI futures, margining, curve construction, and interpolation.

Chapter 5 performs the same job for the most basic FX derivative in Brazil: the DOL, namely a future contract on the BRL/USD exchange rate. Since this represents the price of one US dollar in Brazilian reais, a long position in a DOL future corresponds to a bet that the Real will depreciate against the Dollar in the future. Not all DOL contracts are born the same, however. Because the futures market is open to more participants than the BRL/USD spot market itself, there is an abundance of liquidity concentrated in DOL of the nearest maturity, which are used as an (imperfect) proxy for spot. For those participants who are allowed to operate in the two markets, there is a need to “migrate” positions formed in the more liquid futures market into the less liquid spot market. This is achieved through the *casado* (meaning “married” in Portuguese), whereby a trader simultaneously buys a DOL contract and sells the same amount of dollars in the spot market (or vice-versa). The value of the casado exhibits a typical sawtooth pattern, seen in Figure 66 in the book, and shows the degree to which DOL and spot FX fail to be interchangeable, which can be quite a lot in periods of financial stress.

Things start to get really interesting in Chapter 6, where we meet the first example of a hybrid IR/FX derivative: the DDI, or Dollar DI, namely a future contract on the CDI rate, paid in Brazilian reais, but with notional amount in US dollars. In other words, a DDI contract is a bet on both the exchange rate and the local (Brazilian) interest rates. The resulting rate associated with a DDI contract, is called the “cupom cambial” - a mixture between interest coupons (“cupom”) and exchange rates (“câmbio) - and corresponds to the difference between the Brazilian interest rate and the increase in the exchange rate during the life of the contract. In other words, this can be viewed as the local interest rate in dollars, or equivalently, the payment in reais for dollars invested in Brazil. A long position in a DDI contract is therefore a bet that the cupom cambial will go down in the future, which means either that local interest rates go down or the Real depreciates, or both. Peculiarly, the payoff for a DDI is calculated using the PTAX value quoted one day before maturity of the contract (a prime example of a chainsaw-juggling turtle on top of a post mentioned in Chapter 1), which gives rise to what market participants in Brazil call a “dirty cupom rate”, namely contaminated by exchange rate fluctuations during the last day of the contract. To deal with this potentially troublesome contamination (remember, one day can be a lifetime in FX) the BM&F (“Bolsa Mercantil de Futuros”, the main exchange for derivatives in Brazil) created the deliciously named “FRA de cupom” (when spoken with a carioca accent, a FRA de cupom sounds much more like a dish to be served in Ipanema, like a “caldinho de feijão” or a “bobó de camarão”, than a derivative contract), or FRC. As explained in the book, a long position in an FRC can be seen as a long position in a DDI with maturity T_{2} and a short position in a DDI with maturity T_{1} < T_{2}. After careful analysis, the end result is that the price of an FRC depends on a “clean cupom rate”, that is to say, not contaminated by exchange rate fluctuations near maturity. The remainder of the chapter is dedicated to currency swaps, namely the SCC and SCS contracts (“SC” stands for “swap cambial”, or currency swap), that essentially work in the same way as a DDI contract, namely linking Brazilian interest rates to the BRL/USD exchange rate. This is followed in Chapter 7 by a long and detailed discussion of several IR and FX derivatives traded in Brazil, including the very interesting IDI option, which allows market participants to bet on future Brazilian monetary policy decisions in a way that does not seem to be readily available for monetary policy in other countries.

Up until this point, the book is focussed on so-called onshore (i.e Brazilian) markets for IR and FX products. Chapters 8 and 10 deal with the opposite situation, namely products that depend on Brazilian rates and currency, but are traded in offshore (primarily US) markets. The most well known examples are the BRL/USD future contracts traded in the Chicago Mercantile Exchange (CME), which are paid in US dollars and therefore use the reciprocal PTAX as the reference rate. Another example are offshore over-the-counter (OTC) non-deliverable forwards (NDF) on BRL/USD, which differ from their onshore counterparts by using the EMTA rate, a fallback rate obtained by polling Brazilian currency dealers, instead of the PTAX rate provided by the Brazilian Central Bank. The existence of both offshore and onshore NDFs based on BRL/USD allows one to compute the spread between these two contracts, which turn out to show that offshore contracts sell at a discount whenever there is high demand by foreign investors to be long BRL. This is because it is relatively more difficult for them to open accounts in Brazil and trade in onshore contracts than for Brazilian banks to open accounts abroad, therefore leading to a “premium” charged by Brazilian banks in the form of buying these NDF forwards at a discount compared to the onshore market. A similar dynamics is at play for offshore BRL IR swaps, where foreign investors wanting to profit from high BRL fixed swap rates without having to open accounts in Brazil agree to receive a slightly lower swap rate than in the onshore market. The pricing of these OTC products gives the authors an opportunity to discuss collateralized derivatives and show that they are fully up-to-date (and in some senses ahead) of the emerging literature on this subject

Several portions of the book, in particular Chapters 9, 12, and 13, are dedicated to practical issues, such as the observability of contracts and rates, which contracts to keep constant and which to recalculate when receiving an updated quote, how to deal with date conventions, best practices to mark-to-market, and many other topics that are important for traders but a bit lost on academic readers. For good measure, Chapters 14 and 15 give a brief overview of government bonds and their inflation-linked versions, with the admonition that “a government bond without market, credit or liquidity risk paying a high rate should not exist”, but nevertheless is common in Brazil and epitomizes some of the country’s core economic problems. Chapter 16, on market microstructure is:

- written entirely in bullet point form
- very concise
- interesting but
- somewhat hard to follow
- difficult to connect with the remainder of the book.

In the last chapter, the authors muse about obsolescence of books on financial markets in general, and of their book in particular, given the speed and unpredictability of changes in Brazilian markets. This reminds me of British Prime Minister Harold Macmillan’s response to a journalist when asked what is most likely to blow governments off course: “Events, dear boy, events”. Given the pace of events in Brazil – including the very recent impeachment of President Dilma Rousseff, which happened after the book was published with consequences for the Brazilian economy that are yet to be fully assessed – I dare to predict a successful future for this book, with new editions continuing to make sense of Brazilian markets in years to come.

**UPCOMING CONFERENCES**

This list contains conferences related to mathematical finance that take place in the next three months. A full list is available at http://www.bachelierfinance.org/congresses/conferences.html. Please let us know of conferences we are not aware of and include a URL for the event.

**Innovations in Insurance, Risk- and Asset Management**

April 5–7, 2017

Munich, Germany

**Midwest Mini-Conference on Stochastic Processes and Mathematical Finance**

April 8, 2017

Fargo ND, USA

**Easter School on Quantification and Management of Risk**

April 18–21, 2017

Liverpool, United Kingdom

**MathFinance Conference**

April 20–21, 2017

Frankfurt, Germany

**5th Asian Quantitative Finance Conference**

April 24–26, 2017

Seoul, South Korea

**Second National Conference of Women in Financial Mathematics (WFM2017)**

April 27–28, 2017

Los Angeles CA, USA

**Quantitative Finance at Work**

April 28, 2017

Rome, Italy

**Workshop on Stochastic Analysis in Finance**

May 11–12, 2017

Hong Kong, China

**Mathematical Finance, Probability, and Partial Differential Equations Conference**

May 17–19, 2017

New Brunswick NJ, USA

**Big Data in Predictive Dynamic Econometric Modelling**

May 18–19, 2017

Philadelphia PA, USA

**Conference for the 10th Anniversary of the Center for Financial Mathematics and Actuarial Research**

May 19–21, 2017

Santa Barbara CA, USA

**5th International Symposium on Environment and Energy Finance Issues (ISEFI-2017)**

May 22–23, 2017

Paris, France

**Workshop on Dependence Modelling**

May 22–23, 2017

Island of Aegina, Greece

**School and Workshop on Dynamical Models in Finance
**May 22–24, 2017

Lausanne, Switzerland

**Thera Stochastics–A Mathematics Conference in Honor of Ioannis Karatzas**

May 31 - June 2, 2017

Fira, Santorini, Greece

**Market Microstructure and High Frequency Data**

June 1–3, 2017

Chicago IL, USA

**Young Finance Scholars' Conference**

June 12–13, 2017

Brighton, United Kingdom

**Submission deadline: 1 **May 2017

**Summer School and Workshop on Equilibrium Theory**

June 12–15, 2017

Pittsburgh PA, USA

**Commodity and Energy Markets Conference 2017**

June 14–15, 2017

Oxford, United Kingdom

**3rd Symposium on Quantitative Finance and Risk Analysis, QFRA 2017**

June 15–16, 2017

Corfu, Greece

**8th General AMaMeF Conference**

June 19–23, 2017

Amsterdam, The Netherlands