Saturday, February 4, 2012

1+2 big users of pricing/valuation engine

See also post on secDB usages (http://bigblog.tanbin.com/2011/05/secdb-designed-for-prop-trading.html)

-----A) pre-trade. For any large/small trader, order origination is all about timing, sizing and ...YES, pricing.

A1) quote pricing - on both sell-side and buy-side
** limit order pricing (also stop/stop-limit orders)
** RFQ pricing
** market-maker's pricing engine. Note MM can be a sell-side or buy-side

A1b) pricing other orders -- not all out-going orders are quotes, but I feel quote pricing is the dominant system. If you send out a non-limit order, you can often leverage the same quote pricer. Examples --
A1b1 market orders -- trader must decide at what price level to generate a mkt order
A1b2 cancellations -- someone must decide at what price level to cancel an order.

A2) hedging -- a composite pricing task, though it's included in the pre-trade section. You already have positions so you must mark them and analyze their sensitivities, then price your hedging orders

A3) pre-trade valuation analysis. Very important in structured/exotic trading desk.

A4) pricing control -- compliance, both internal and external (regulatory)
-----B) post-trade
B1) marking -- mark to market, either real time or periodic. Basis of VaR and pre-trade pricing
** EOD/EOM/EOQ PnL
** General Ledger -- I worked with KPMG auditors. They have a big responsibility to scrutinize these valuations
** regulatory reporting

B2) market-risk -- most complex usage
** sensitivity -- affects hedging pricing
** correlation and hedging
** VaR

B3) margin calc
B4) collateral re-valuation. Most long-term contracts are backed by collateral and need to be re-valued.
B5) market-value based fee calculation -- the oxygen of portfolio managers
B6) bonus
-----------
If I must name Big 3 users, I'd single out 1) quote pricer (including market-making), 2) marking and 3) VaR. 

In one major derivative desk (market leader), the same pricing model is used in 2 primary pricers -- RFQ and risk. These are 2 distinct software applications, though based on the same pricing model.

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New York (Time Square), NY, United States
http://www.linkedin.com/in/tanbin