Valuation - IPV
Q1 What IPV stands for?
IPV stands for Internal Price Verification and in a lot of banks it is the other name given to the Valuation Control Group.
Q2 How is the valuation performed / on which frequency?
The valuation is performed on a monthly or daily basis depending on the type of products by comparing the data received to the internal marks of the bank.
Q3 What can be the different data sources?
The sources vary but are mainly totem (also named markit), especially for the option / exotic world. For the more linear products such as bonds, bloomberg or reuters or different brokers can be used depending on the specific market.
Q4 How the IPV would be performed for example on bonds?
The process could happen on a daily basis where the IPV could take the form of (bloomberg price - internal price ) * quantity. Then this amount could be charged to the trading desk as the bloomberg mark could be deemed more appropriated.
However most of the time there is a buffer which could be linked for example to the volatility of the product or the price of a second vendor. And only above this level then the desk could be charged until reaching the official price.
Q5 What would be the IPV methodology on swaptions?
On swaptions, most banks used a SABR model, it is a stochastic model which contains a few parameters: alpha (vol of vol), beta, rho, displacement.
However the price received, usually banks use totem is only 1 value. So for example price us 1.94 for 1y2y ATM payer swaption.
It means some calibration need to take place to make sure the SABR parameters fit as well as possible the prices receive. In other terms to minimize the difference between the calibrated price and the consensus price received.One of the potential calibration approach in case we want to focus on only 1 parameter, could be a least square method.
Q6 What are the other responsibilities of the valuation group?
The core responsibility is to make sure the books are priced at fair value.
But there are other responsibilities such as responsible for the levelling. The levelling is representative of the liquidy of an instrument and has different regulator charged based on the level. In terms of rough approximation, level 1 is liquid with prices easily available when level 3 is more illiquid with not easily available prices.
Moreover in case of significant day1 P&L (P&L at trade inception), the valuation team will review the inputs to make sure the price is correct.
Q7 Tell me about an exotic productAn example is cancellable swaps.
It contains a Bermudan swaption and a swap. The idea being is at a certain set of dates the Bermudan swaption can cancel the swap (hence the name).In terms of pricing, the delta curves need to be defined (from swaps prices), the volatility surfaces need to be defined (from swaptions), then the correlation of the coterminal swaption (which is the correlation between for example the 1yr and 5yr Bermudan swaption) needs to be defined (from the cancellable swap prices) to be able to perform the IPV.