ICM286-Advanced Derivatives Modelling

Module Provider: ICMA Centre
Number of credits: 20 [10 ECTS credits]
Terms in which taught: Spring term module
Pre-requisites: ICM127 Stochastic Calculus and Probability
Non-modular pre-requisites:
Modules excluded:
Module version for: 2017/8

Module Convenor: Dr Emese Lazar

Email: e.lazar@icmacentre.ac.uk

Summary module description:

This module discusses the pricing methods used for derivative products in three markets, namely the equity & foreign exchange, interest rate and credit products. The pricing of several exotic derivatives is discussed and popular advanced models are introduced.

This module aims to introduce the models and pricing methodologies characteristic for three markets, namely equity and foreign exchange, interest rate and credit derivatives markets. For the equity and FX derivatives markets it aims to introduce models beyond Black-Scholes to price non-vanilla instruments. For interest rate derivatives markets arbitrage-free term structure models are considered. For credit derivatives we introduce the default intensity approach for the valuation of single name default swaps and the pricing of OTC derivatives in the presence of counterparty risk.

Assessable learning outcomes:
By the end of the module, it is expected that the student will be able to:
• characterize and compare different methods and frameworks used to price exotic derivatives in the equity and FX, interest rate and credit area
• derive the price, assuming different methods, for a variety of equity and FX, interest rate and credit derivatives

Additional outcomes:
The module creates awareness of the exotic products and the methodology used to price derivatives in these markets. This will also create motivation and background for further study in other areas.

Outline content:
I. Equity and FX derivatives
a. Products (non-vanilla):
- terminal payoffs which depend only on the distribution of the underlying at expiration,
- mildly path-dependent payoffs which depend on forward distributions (or conditional distributions) of the underlying,
- strongly path-dependent payoffs which depend on the full dynamics of the underlying.
b. Models:
- pricing with implied risk-neutral distributions,
- local volatility models,
- stochastic volatility models, mainly Heston model.

II. Interest rate derivatives
a. Products:
- caps/floors,
- swaptions,
- exotics.
b. Models:
- models that assume one discount curve and multiple index curves,
- HJM (Heath-Jarrow-Morton) modelling framework in the presence of stochastic tenor basis,
- two of the most widely used HJM models: Gaussian and Squared gaussian models,
- basic LIBOR market model

III. Credit derivatives
a. Products:
- credit default swaps (CDS),
- quanto CDS,
- OTC portfolio (CVA).
b. Models:
- hazard rate models.

Brief description of teaching and learning methods:
Lectures supported by discussion of homework assignment in interactive seminars.
Teaching is based on tailor made lecture notes.
In addition frequent reference is made to the recommended textbooks.
Compulsory homework assignments are set weekly.

Contact hours:
  Autumn Spring Summer
Lectures 20
Seminars 10
Guided independent study 170
Total hours by term 200.00
Total hours for module 200.00

Summative Assessment Methods:
Method Percentage
Written exam 60
Written assignment including essay 40

Other information on summative assessment:
2 hours open-book written examination

Formative assessment methods:

Penalties for late submission:
Penalties for late submission on this module are in accordance with the University policy. Please refer to page 5 of the Postgraduate Guide to Assessment for further information: http://www.reading.ac.uk/internal/exams/student/exa-guidePG.aspx

Length of examination:
2 hours.

Requirements for a pass:
50% weighted average mark

Reassessment arrangements:
By written examination only, as part of the overall examination arrangements for the MSc programme.

Additional Costs (specified where applicable):
1) Required text books: 1. Steven E. Shreve: Stochastic Calculus for Finance II: Continuous-Time Models (volume 2) Springer Finance, 2008, ISBN-10: 0387401016, £49.99.
2. Jim Gatheral, Nassim Nicholas Taleb: The Volatility Surface: A Practitioner's Guide Wiley Finance, 2006, ISBN-10: 0471792519, £47.50.
3. Antoon Pelsser: Efficient Methods for Valuing Interest Rate Derivatives Springer Finance, 2000, ISBN-10: 1852333049, £60.99.
2) Specialist equipment or materials:
3) Specialist clothing, footwear or headgear:
4) Printing and binding:
5) Computers and devices with a particular specification:
6) Travel, accommodation and subsistence:

Last updated: 31 March 2017

Things to do now