Hi All,I was reading the chapter about IVF on Hull's book (Options, Futures and Other Derivatives pg.569 6th ed.). He ends the chapter stating that the model prices correctly options that provide payoffs at just one time, "However, the model does not necessarily get the joint distribution of the asset price at two or more times correct. This means that exotic options such as compund options and barrier options may be priced incorrectly".I'm doing some research to create a short list of possible topics that I could use for my MSc thesis. I had, in the past, several chat on this model, and I was told to be one of most cutting edge in option pricing. However, this sentence makes me doubt about it. Could anyone that uses it daily or that is involved in option pricing comment its flawnesses and maybe give some advice on other models that actually used in banks?Thank you so much for your help,japanstar

What is IVF ? Given Hull's point, it seems to be the integration of the payoff against the terminal distribution implied from the vanilla market, is this correct ?

QuoteOriginally posted by: islingtonWhat is IVF ? IVF

QuoteOriginally posted by: japanstarHi All,I was reading the chapter about IVF on Hull's book (Options, Futures and Other Derivatives pg.569 6th ed.). He ends the chapter stating that the model prices correctly options that provide payoffs at just one time, "However, the model does not necessarily get the joint distribution of the asset price at two or more times correct. This means that exotic options such as compund options and barrier options may be priced incorrectly".I'm doing some research to create a short list of possible topics that I could use for my MSc thesis. I had, in the past, several chat on this model, and I was told to be one of most cutting edge in option pricing. However, this sentence makes me doubt about it. Could anyone that uses it daily or that is involved in option pricing comment its flawnesses and maybe give some advice on other models that actually used in banks?Thank you so much for your help,japanstarHull's comments are correct.There are many other critiques of the IVF, aka local volatility. This paper by Dumas, Fleming, and Whaley is often cited and may be found online.To find these critiques, google for papers that cite this one and search the forums for threads with 'local volatility'.

Thank you Alan.japanstar