An exotic derivative, in
finance
Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fina ...
, is a
derivative
In mathematics, the derivative of a function of a real variable measures the sensitivity to change of the function value (output value) with respect to a change in its argument (input value). Derivatives are a fundamental tool of calculus. F ...
which is more complex than commonly traded "vanilla" products. This complexity usually relates to determination of payoff; see
option style In finance, the style or family of an option is the class into which the option falls, usually defined by the dates on which the option may be exercised. The vast majority of options are either European or American (style) options. These optionsâ ...
.
The category may also include derivatives with a non-standard subject matter - i.e.,
underlying
In finance, a derivative is a contract that ''derives'' its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying". Derivatives can be use ...
- developed for a particular client or a particular market.
[Understanding derivative contracts: types of derivatives](_blank)
The term "exotic derivative" has no precisely defined meaning, being a colloquialism that reflects how common a particular derivative is in the marketplace. As such, certain derivative instruments have been considered exotic when conceived of and sold, but lost this status when they were traded with significant enough volume. Examples of this phenomenon include
interest rate- and
currency-swaps.
As regards
valuation, given their complexity, exotic derivatives are usually
modelled
A model is a person with a role either to promote, display or advertise commercial products (notably fashion clothing in fashion shows) or to serve as a visual aid for people who are creating works of art or to pose for photography. Though mo ...
using specialized
simulation- or
lattice-based techniques. Often, it is possible, to "manufacture" the exotic derivative out of standard derivatives.
Emanuel Derman
/ref> For example, a knockout call can be "manufactured" out of standard options; see . This latter approach may then be preferred, and also allows for a benchmark against which the more specialized models may be verified.
See also
*Exotic option
In finance, an exotic option is an option which has features making it more complex than commonly traded vanilla options. Like the more general exotic derivatives they may have several triggers relating to determination of payoff. An exotic opt ...
*Financial engineering
Financial engineering is a multidisciplinary field involving financial theory, methods of engineering, tools of mathematics and the practice of programming. It has also been defined as the application of technical methods, especially from mathema ...
*Financial innovation
Financial innovation is the act of creating new financial instruments as well as new financial technologies, institutions, and markets. Recent financial innovations include hedge funds, private equity, weather derivatives, retail-structured pro ...
*Structured product
A structured product, also known as a market-linked investment, is a pre-packaged structured finance investment strategy based on a single Security (finance), security, a basket of securities, Option (finance), options, Index (economics), indices, ...
References
External links
Understanding derivative contracts: types of derivatives
HM Revenue & Customs
HM Revenue and Customs (His Majesty's Revenue and Customs, or HMRC) is a non-ministerial government department, non-ministerial Departments of the United Kingdom Government, department of the His Majesty's Government, UK Government responsible fo ...
Exotic Derivatives and Structured Products
SĂ©bastien Bossu, University of Chicago
The University of Chicago (UChicago, Chicago, U of C, or UChi) is a private research university in Chicago, Illinois. Its main campus is located in Chicago's Hyde Park neighborhood. The University of Chicago is consistently ranked among the b ...
Exotic Derivatives
, Prof. Jim Gatheral
Jim Gatheral is a researcher in the field of mathematical finance, who has contributed to the study of volatility as applied to the pricing and risk management of derivatives. A recurrent subject in his books and papers is the volatility smile, ...
, Baruch College
Baruch College (officially the Bernard M. Baruch College) is a public college in New York City. It is a constituent college of the City University of New York system. Named for financier and statesman Bernard M. Baruch, the college operates und ...
Exotic Equity Derivatives Manual
Salomon Smith Barney
Salomon Brothers, Inc., was an American multinational bulge bracket investment bank headquartered in New York. It was one of the five largest investment banking enterprises in the United States and the most profitable firm on Wall Street durin ...
(1998)
Guide to Exotic Credit Derivatives
Lehman Brothers
Lehman Brothers Holdings Inc. ( ) was an American global financial services firm founded in 1847. Before Bankruptcy of Lehman Brothers, filing for bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Gol ...
A Day in the Life of an Exotic Derivatives Trader
quantnet.com
Derivatives (finance)
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