Risk and Pricing Analytics: Addressing Valuation Challenges in OTC and Structured Products
Abstract
Celent predicts OTC derivatives will cross the US$550 trillion mark in 2008, up from US$375 trillion as of year end 2006.
Growing OTC derivatives trading volume, escalating exposure to over-the-counter (OTC) derivatives and structured deals, the increased complexity of products, and lack of trade automation have increased the importance of accurate valuation, according to the new Celent report, .
Recent incidents associated with Amaranth Advisors and Bank of Montreal’s loss illustrate the risks associated with the use of derivative instruments. They also bring to light the need to address inappropriate valuation practices and insufficient management oversight. At the heart of things, pricing and valuation of financial assets are core to a financial institution’s existence and tied to the stability of the financial sector as a whole. Accordingly, getting it right is crucial.
"As a whole, the determination of fair market value for the positions that make up a complex trade, fund, or portfolio is, more often than not, fraught with complications," says Cubillas Ding, Celent analyst and author of the report. "Complexities often arise from multi-layered product valuation requirements, the fault-prone use of spreadsheets, and the transparency of valuation processes."
To address this situation, vendors have adopted different "routes to market" for pricing analytics. Solutions are differentiated along several lines: specialized vs. mixed asset models, coverage across various parts of the OTC and structuring lifestyle, scope of vendors’ analytics, and the quality of partnerships related to market data, integrated trading, and risk management systems.
Ding says that institutions implementing pricing solutions need to weigh the level of granularity required for their OTC derivatives and structured products valuation activities, the type and nature of users, and time-to-market considerations in the context of the availability of internal resources. "Each approach trades off granularity, end user focus, and time to market," he adds.
In this report, Celent examines the activities around securities pricing and draws lessons from valuation challenges, as well as highlighting considerations for the implementation of solutions.
Eight firms are profiled in this report, which contains pertinent information about each vendor solution, including company and organizational details, solution strengths and drawbacks, reference feedback, market presence, and solution coverage. Vendors covered include FinCAD, NumeriX, Pricing Partners, Quantify Solutions, SciComp, SunGard Reech, SuperDerivatives, and UniRist / MathConsult.
The 45-page report contains 19 figures and tables. A table of contents is available online.
Members of Celent's research services can download the report electronically by clicking on the icon to the left. Non-members should contact info@celent.com for more information.