An Analysis of Risks in OTC-Derivative Pricing : Examining, quantifying, and analyzing the risks associated with the varying of a subset of configurations and input parameters using the swaption as an illustratory tool

Sammanfattning

The pricing of over-the-counter derivatives (OTC-derivatives) can be a complicated process, with many moving parts, where many things can go wrong. In addition, European Securities and Markets Authority (ESMA) requirements for non-cleared OTC-derivatives are somewhat non-specific. The main goal of this thesis is to perform a sensitivity analysis with respect to price on the configuration and input parameters of OTC-derivatives, with a swaption serving as the illustrative instrument. This thesis analyzes the risks of mispricing instruments from three possible sources of error; the data intraday sampling time, the model type, and the conventions used when configuring the instrument. These are compared using various risk and performance measures and discussed from an Industrial Economics and Management perspective. It is shown that the models differ in pricing most when making future predictions assuming fixed data, that the intraday data sampling time causes pricing differences sporadically, and that certain conventions exist that cause highly significant mispricings. The main conclusion from these findings is the necessity of extensive theoretical understanding when designing and auditing Mark-to-Model routines.