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Manufacturing and Managing Customer-Driven Derivatives
DONG QU
This edition first published 2016
© 2016 Dong Qu
First edition published 2016
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Library of Congress Cataloging-in-Publication Data is Available
ISBN 9781118632628 (hardback) ISBN 9781118632529 (ePDF)
ISBN 9781118632536 (ePub)
Cover Design: Wiley
Cover Images: Top Image © stocker1970/Shutterstock; Bottom Image © photofriday/Shutterstock
To my wife and children: all of them have contributed in their own ways
Derivatives have long diffused into the financial systems as trading, hedging and risk management instruments, on and off balance sheets, embedded in assets and liabilities. In an industry that is increasingly focusing on value-added activities, customer-driven derivatives will continue to play key roles in the retail, private, corporate and institutional derivatives markets.
Managed properly, customer-driven derivatives business can be a rewarding business with high capital efficiency. It offers tailor-made investment and hedging solutions to the customers, and can be a very valuable source of funding for banks, even in a time of crises. The capital efficiency mainly comes from the fact that the bulk of the business is customer-driven. By its nature, this business requires efficiency and flexibility in product offering.
While it is true that the customer-driven derivative products have overall become simpler, manufacturing and managing these products has actually become more complex, due to macro factors such as the multi-curve environments triggered by the recent financial crises, stricter regulatory requirements of consistent modelling and managing frameworks, and the needs to optimize risk/reward profiles.
This book aims to present a holistic view of the customer-driven derivatives business, coupled with forensic quantitative model analyses from a practical perspective:
• It explains the life cycle of the derivative products, the manufacturing process of turning models into products, the key pillars of the business infrastructure and the regulatory framework, including Basel III and beyond.
• It explores quantitative pricing models and their applications, explaining various model paradigms and non-arbitrage models used in real equity and interest rate derivatives business. Smile/skew topics are examined in depth. The multi-curve environment and its practical impact on interest rate derivatives pricing are discussed extensively. Key derivative risks are also highlighted, and the focus is on combining or balancing the model simplicity with the necessity to capture the risks.
