May 19, 2010
The bespoke nature of OTC derivatives and structured deals makes pricing and risk evaluation an extraordinary challenge. Traditionally, due to prohibitive costs and the limited number of options available, most banks, asset managers, and hedge funds overcame this obstacle by depending on broker-dealers to furnish prices for instruments with more complex payout structures. In recent years, however, the industry has seen banks and investment firms build up their own pricing and valuation capabilities to counter this overreliance.
Approaches adopted for the development and provisioning of these analytics/models are, more often than not, independently charted and typically uncoordinated across various asset classes. As such, these incur compounded levels of expenditure in the provisioning, deployment, and consumption of analytics and models. Furthermore, direct in-house procurement of quantitative expertise is expensive for a firm, with significant integration efforts and ownership costs.
In this report from Celent and FINCAD, findings suggest the total costs of building, maintaining and enhancing a complete derivatives library can range from $25 to $36 million, aggregated over the total software lifecycle. Firms with significant in-house development efforts need to re-examine how internal development differentiates the firm, weigh it against continuing costs and control overheads, and subsequently consider whether to build or buy models in the longer term. Where feasible, it may make sense to employ off-the-shelf pricing analytics and valuation services to improve cost efficiency across front, middle, and back offices, especially for more conventional pricing models and commoditized library functions.