Derivatives pricing models from "summary" of Introduction to Finance by Ronald W. Melicher,Edgar A. Norton
Derivatives pricing models are used to predict the future value of a financial instrument, such as stocks, bonds or options, based on its past performance and market conditions. They are an important tool for investors and financial institutions to make informed decisions.- Derivatives pricing models measure the amount of risk incorporated in a financial instrument such as futures, options and forwards. These models take into account supply and demand levels for the underlying asset to determine its value.
- The most commonly used derivatives pricing model is Black-Scholes Model. It helps find present values of options by using volatility, time to expiry, the current stock price , dividend yield and interest rate as input variables.
- Derivatives have some unique characteristics such as expiration date, strike price, exercise style, and premium or margin requirements which help analysts develop pricing models to set their related values.
- Other popular models for pricing derivatives include binomial option pricing, trinomial tree option pricing, Margrabe's model, Heat Ballew’s Delta Formula and Garman-Kohlhagen Currency Option Pricing Model.
- There are several heuristics models available as well like delta hedging and gamma hedging. They aim at reducing the market risk of options by maintaining a balance between the gains and losses due to changes in the prices of the underlying asset.
- For accurate estimates, it is important to select an appropriate index relevant to the derivative being priced. Also, account the change in trend and any unexpected events that can affect the asset to make best use of the model.
