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Derivatives Analytics with Python: Data Analysis, Models, Simulation, Calibration and Hedging


Author: Yves Hilpisch

Publisher: Wiley


Publish Date: August 3, 2015

ISBN-10: 1119037999

Pages: 376

File Type: PDF

Language: English

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Book Preface

This book is about the market-based valuation of (stock) index options. In the domain of derivatives analytics this is an important task which every major investment bank and buy-side decision maker in the financial market is concerned with on a daily basis. While theoretical valuation approaches develop a model, parametrize it and then derive values for options, the market-based approach works the other way round. Prices from liquidly traded options are taken as given (i.e. they are inputs instead of outputs) and one tries to parametrize a market model in a way that replicates the observed option prices as well as possible. This activity is generally referred to as model calibration. Being equipped with a calibrated model, one then proceeds with the task at hand, be it valuation, trading, investing, hedging or risk management. A bit more specifically, one might be interested in pricing and hedging an exotic derivative instrument with such a model—hoping that the results are in line with the overall market (i.e. arbitrage-free and even “fair”) due to the previous calibration to more simple, vanilla instruments.

To accomplish a market-based valuation, four areas have to be covered:

1. market: knowledge about market realities is a conditio sine qua non for any sincere attempt to develop market-consistent models and to accomplish market-based valuation

2. theory: every valuation must be grounded on a sound market model, ensuring, for example, the absence of arbitrage opportunities and providing means to derive option values from observed quantities

3. numerics: one cannot hope to work with analytical results only; numerical techniques, like Monte Carlo simulation, are generally required in different steps of a market-based valuation process

4. technology: to implement numerical techniques efficiently, one is dependent on appropriate technology (hard- and software)

This book covers all of these areas in an integrated manner. It uses equity index options as the prime example for derivative instruments throughout. This, among others, allows to abstract from dividend related issues.

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