Wednesday, April 13, 2016

Reflections on risk, regulation and model revision

Pricing perspectives continue to come under scrutiny in 2016. Consider the following communications by leading researchers this year on FVA:

[Hull] Models and measures 1 & 2 (2 Feb 2016)
"Risk-neutral valuation is without doubt the most important single principle in derivative pricing. If we did not have risk-neutral valuation, we would have to make estimates of the return provided by underlying market variables in the real world and then quantify the riskiness of the payoff in some way to determine the correct discount rate." (1 Mar 2016)
"But it should always be remembered that a risk-neutral world is nothing more than an artificial construct. It does not describe how market variables behave in the real world, the world we actually live in."

[Duffie] You're doing Swaps Account wrong (11 Mar 2016) (11 Mar  2016)
"Nitpicking over a $500,000 cost on a $100 million trade might seem inconsequential, but the market for interest-rate swaps, the largest in the world, is $319 trillion in size, according to the Bank for International Settlements. Even small errors matter."

and here is Hull on the ongoing FVA debate: (26 Nov 2015)


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