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MaestroQuant
Topic Author
Posts: 1
Joined: September 27th, 2017, 12:26 pm

Which model for which fixed-income product?

September 27th, 2017, 1:57 pm

Hi
I am working in Fixed-income department and I would like to know how to choose the correct model (1, 2 or 3 factors) for the given products and the reason why we choose a model:

- credit default swaps
- inflation swaps
- bond options (callable bond, puttable bond, convertible bond, extendible bond; exchangeable bond) 
- swaptions on rates
- bermudan
-barrier options
- american options (vanilla or barrier)
- quanto adjustment for IR options 
- IR options
- cross currency swaps
- variance swaps
- TARN, Range accrual, TARF
-other types of derivatives needed a model?

Thanks,

Regards.
 
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Tedypendah
Posts: 55
Joined: May 26th, 2013, 10:11 am

Re: Which model for which fixed-income product?

October 3rd, 2017, 3:25 am

Have you seen Options, Futures and Other Derivatives by Hull? Do you understand how the products work?
 
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Pat
Posts: 28
Joined: September 30th, 2001, 2:08 am

Re: Which model for which fixed-income product?

October 5th, 2017, 2:32 pm

The general rules:
A. The calibrated model has to simultaneously price the deal AND it's hedging instruments
          --- when you hedge (and re-hedge!) a deal, you are really selling the opposite deal
          --- it's largely irrelevant whether the model correctly prices other deals or deal types to their market values ... if Im trying to price the US gasoline derivatives, I'll discard models that simultaneously price Mongolian Yak futures ... it's just needless complications
B. it must lead to stable hedges ... otherwise any potential profit will leak away due to hedging "chatter"
C. Simple is good ... you really want the simplest model for that particular deal that covers the key risk factors for that particular deal. Complexity is always costly.

For each product on your list,write down the key risks and the hedging instruments. Start with a one factor model that handles the primary  risk, and if that doesn't work adequately in practice, add another factor for the next risk. Don't get sucked into the "it matters, so throw it in" ... this results in models with a milion different factors which cannot be calibrated stably (and thus have unstable risks) and are unusable.
 
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Orbit
Posts: 36
Joined: October 14th, 2003, 5:34 pm

Re: Which model for which fixed-income product?

December 19th, 2017, 6:59 pm

The general rules:
A. The calibrated model has to simultaneously price the deal AND it's hedging instruments
          --- when you hedge (and re-hedge!) a deal, you are really selling the opposite deal
          --- it's largely irrelevant whether the model correctly prices other deals or deal types to their market values ... if Im trying to price the US gasoline derivatives, I'll discard models that simultaneously price Mongolian Yak futures ... it's just needless complications
B. it must lead to stable hedges ... otherwise any potential profit will leak away due to hedging "chatter"
C. Simple is good ... you really want the simplest model for that particular deal that covers the key risk factors for that particular deal. Complexity is always costly.

For each product on your list,write down the key risks and the hedging instruments. Start with a one factor model that handles the primary  risk, and if that doesn't work adequately in practice, add another factor for the next risk. Don't get sucked into the "it matters, so throw it in" ... this results in models with a milion different factors which cannot be calibrated stably (and thus have unstable risks) and are unusable.
IMHO this is one of the most thoughtful, clear and incisive descriptions of model selection, EVER.
 
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berndL
Posts: 31
Joined: August 22nd, 2007, 3:46 pm

Re: Which model for which fixed-income product?

December 29th, 2017, 12:01 pm

Hi
I am working in Fixed-income department and I would like to know how to choose the correct model (1, 2 or 3 factors) for the given products and the reason why we choose a model:

- credit default swaps
- inflation swaps
- bond options (callable bond, puttable bond, convertible bond, extendible bond; exchangeable bond) 
- swaptions on rates
- bermudan
-barrier options
- american options (vanilla or barrier)
- quanto adjustment for IR options 
- IR options
- cross currency swaps
- variance swaps
- TARN, Range accrual, TARF
-other types of derivatives needed a model?

Thanks,

Regards.
ask yourself how you would hedge these products.
And if its not you who is going to hedge: Ask the person who is going to hedge.  Do you then agree with him? Then he (if its not you) will also have a model in mind.