Nov 5, 2010

FX-Fixed Income Hybrids: Practical Pricing Issues

On November 2nd, Numerix hosted a complimentary webinar led by Senior Quantitative Analyst, Olga Us, discussing the valuation and pricing issues surrounding long-dated, interest rate products. You can access a replay of the webinar here.

Webinar Highlights

The presentation began with an initial discussion outlining the five key steps (and questions you should ask!) that should be implemented for a successful pricing process when valuing these complex instruments. Ms. Us also cautioned about the importance of utilizing accurate market data, citing that it is often the most ‘overlooked area’ in the model review process; yet, clearly it is paramount.

What Are the Five Building Blocks for a Sound Valuation Process?

Senior Quantitative Analyst, Olga Us, highlighted the key points below:

  1.  Correct market data & appropriate usage
      (Is our market data used appropriately?)
  2.   Model choice & richness to capture all risk factors
     (Does our model capture risks? Is it reasonably complex?)
  3.   Accurate and robust model calibration
     (Is our calibration adequate and accurate?)
  4.   Correct payoff structuring
      (Does our pricing correctly reflect the payoff? Is it transparent?)
  5.   Benchmarking results to the market
      (Can we easily verify the results?)

Pricing Issues: Key ‘Takeaways’—from Data to Benchmarking

Market data should be used carefully.

  • This is the most overlooked area in the model review process.
  • No matter how good the model is, a poor choice or inappropriate usage of input data can distort the valuation results significantly.

Choosing the right model takes practice and experience.

  • The choice of model is perceived to be harder then it really is, and boils down to a few simple rules.
  • The key thing is to be able to access and compare how the valuation changes as a result of different modeling assumptions, and with different model features switched on and off.

Calibration of a model is never perfect: There is always room for improvement.

  • Choice of calibrating instruments reflects the payoff structure.
  • Consistent model calibration can mean altering the payoff.
  • Look-out for problems with joint calibration.

Flexible pricing environment is essential for robust and transparent pricing.

  • Stripping the payoff into its parts at the level of scripting.
  • Extending the payoff to more generic cases.
  • Hidden shortcuts.

(Did you remember to check convergence in your numerical valuation?)

Benchmarking can bring us back to the start of valuation. This is a foolproof test for any pricer.

  • The final analysis of the cashflows is crucial.
  • It includes decomposition and analysis of how the price is accumulated throughout the life of a deal and replication of model-independent blocks.

Cashflow Analysis


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