306 Frequently Asked Questions In Quantitative Finance
Things to Look Out for in Exotic
Contracts
There are six important features to look out for in exotic
contracts. Understanding these features will help you
price a contract. These features are as follows.
1.Time dependence
2.Cashflows
3.Path dependence
4.Dimensionality
5.Order
6.Embedded decisions
If you can classify an exotic contract according to these
characteristics you will be able to determine the following.
- What kind of pricing method should best be used
- Whether you can re-use some old code
- How long it will take you to code it up
- How fast it will eventually run
Time dependence is when the terms of an exotic contract
specify special dates or periods on or during which
something happens, such as a cashflow, or early exercise,
or an event is triggered. Time dependence is first on our
list of features, since it is a very basic concept.
- Time dependence in an option contract means that
our numerical discretization may have to be lined up
to coincide with times at, or periods during which,
something happens.
- This means that our code will have to keep track of
time, dates, etc. This is not difficult, just annoying.
