Thursday, December 30, 2010

models are optional or as indispensible as trade capture@@

(A blog post. No need to reply)
Trade booking is the most essential component of any trading system. If a small trader has no computer system, he would make do with a poor man's trade booking tool like Excel or physical paper to record the trades he did and the positions he holds.

Now compare quant models. I feel models are optional. It depends on the asset class spectrum. On one extreme end are listed equity options. The other extreme might be vanilla government bonds.

Vanilla Government bonds (not futures/options) involve no option-pricing, and are risk-free (notwithstanding the recent Greek/Irish defaults). I would assume there's no need for quantitative model in pricing/risk systems.

Treasury futures is a different story. There are models to predict price distribution of underlying asset. Since the price is in the future, there are probabilities to work out -- a branch of statistical mathematics.

Muni cash bonds need some model? not much. There's perhaps some credit risk mathematics. The models generate a bid/offer price pair for each bond (based on the position held by the trader), but a trader offering the same bond can choose to use that price (plus a spread) or ignore it. It's optional to a lot of muni traders.

On the extreme end of the spectrum, listed equity options are priced and quoted on exchanges using widely agreed models (lognormal stuff). Are models necessary to a trader in this market? Can an investor simply follow her instinct to decide for herself a bid/offer price?

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