Market Price vs Model Price
Keep observed quotes separate from calculated fair values.
Name the object before manipulating it.
A market price is an observation with venue, timestamp and executable conditions. A model price is a conditional calculation under inputs and assumptions.
Keep observed quotes separate from calculated fair values.
State the governing relationship.
Notation and units
Decimal rates and volatilities, year-fraction time and continuous compounding unless stated otherwise.
Draw the boundary of the claim.
Definitions, units and information sets are fixed before the mathematical relationship is applied.
Rates and volatilities use decimal units and time uses year fractions unless stated otherwise.
The relationship is local to its stated assumptions and should not be extrapolated mechanically.
“An unstated convention is a future reconciliation break.”— THEQUANTBATEMAN
Connect the definition to an observable.
Calibration, relative-value analysis and governance depend on never confusing the two.
Translate the concept into a risk question.
State the convention, identify the observable and ask which Foundations risk remains after the proposed hedge.
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