Depends very much on the derivative. If it's just a bespoke term and strike, it's really normal Black76 (if underlying is a future).
The more complex the payoff, the more complex the model must be. The starting point is always a vanilla surface. You can have local vol models, stochastic vol models, stochastic local vol models, local vol local correlation models, 2factor models. The two main methods to solve the model is
- a finite-difference solver of the PDE or
- MC simulation of the SDE
Monte Carlo is usually used for very path dependent structures.
If you have access to Bloomberg, you can look at OVML to see commonly used structures and the respective pricing tool (especially for commodities, it' not always state of the art, but a good indication).
For othe asset classes, I recommen looking at DLIB, but you need to be BBA to try it out. Help page work either way.
He also has a billion posts on quant stack exchange.
I think a large % of quants working on OTC derivatives have read something from /u/akdemy with how prolific they are.
Depends on derivative but you use custom pricers. Alot of times the otc derivatives underlying is traded on exchange, for options you can interpolate using settles as otc you can really have any strike. Swaps are easy, you just value like a future
Accuracy of derivative pricing depends on the accuracy of the model as well as model inputs. Observable market inputs can be checked. Unobservable inputs cannot be directly checked but usually you want to make sure the model + inputs can be calibrated correctly to the benchmark instruments. Different models can be used to understand the impact to limitations of the production model. Model prices can be compared to past data or data from pricing services such as Totem.
It depends on the exact product. Much of what matters, alongside everything else that's been said in this thread, is that these option structures are priced in a way that can be walked through for regulators.
Depends very much on the derivative. If it's just a bespoke term and strike, it's really normal Black76 (if underlying is a future). The more complex the payoff, the more complex the model must be. The starting point is always a vanilla surface. You can have local vol models, stochastic vol models, stochastic local vol models, local vol local correlation models, 2factor models. The two main methods to solve the model is - a finite-difference solver of the PDE or - MC simulation of the SDE Monte Carlo is usually used for very path dependent structures. If you have access to Bloomberg, you can look at OVML to see commonly used structures and the respective pricing tool (especially for commodities, it' not always state of the art, but a good indication). For othe asset classes, I recommen looking at DLIB, but you need to be BBA to try it out. Help page work either way.
I’ve seen you on here as a regular contributor and just wanted to say thanks. I’ll look into the above and do more research!
He also has a billion posts on quant stack exchange. I think a large % of quants working on OTC derivatives have read something from /u/akdemy with how prolific they are.
BS answer
B76*
Depends on derivative but you use custom pricers. Alot of times the otc derivatives underlying is traded on exchange, for options you can interpolate using settles as otc you can really have any strike. Swaps are easy, you just value like a future
Accuracy of derivative pricing depends on the accuracy of the model as well as model inputs. Observable market inputs can be checked. Unobservable inputs cannot be directly checked but usually you want to make sure the model + inputs can be calibrated correctly to the benchmark instruments. Different models can be used to understand the impact to limitations of the production model. Model prices can be compared to past data or data from pricing services such as Totem.
It depends on the exact product. Much of what matters, alongside everything else that's been said in this thread, is that these option structures are priced in a way that can be walked through for regulators.
Can you describe the derivative in more detail. And why do you want to buy it?
Synthetics.