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I am trying to understand the purpose of inputs the software of my company is using. Amongst others it needs calibration instruments, a model type, initial values of the respective underylings and a yield curve. Furthermore one can input the forward price curve of the respective underlyings. The pricing of derivatives is done by Monte Carlo. Where in the pricing pipeline would it be possible/useful to use the forward price curve?

Edit:

The forward curve is not passed directly. Instead a repocurve is passed which is calculated by adding a bump to the yield curve

algebruh
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    Normally, you can either input a) spot prices + yield curve, or b) forward prices. – Daneel Olivaw Oct 15 '21 at 10:11
  • The original Black Scholes Merton formula was written in terms of the spot price S, but a few years later Fischer Black showed that it was (slightly) simpler if written in terms of the forward price F. Which makes sense since the option involves a delivery in the future (at maturity) so the forward price at that maturity is natural to consider. – nbbo2 Oct 15 '21 at 10:29
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    Not sure what underlying you want to know about specifically but here is a working example showing the equivalence of Black Scholes (spot) and Black76 (forward). Generally, I suggest asking at work directly. I doubt anyone minds explaining implementations if you need this for work. – AKdemy Oct 15 '21 at 10:37
  • @DaneelOlivaw in this case spot, yield curve and forward prices are passed – algebruh Oct 15 '21 at 12:03
  • @noob2 The final goal is to price exotic derivatives with Monte Carlo. Therefore there is no analytical formulat in which one could input forward prices. – algebruh Oct 15 '21 at 12:04
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    @Roman27 what is the "yield curve" exactly? If the input yield curve is expected to be pure interest rate, then the forward contains asset-specific term structure information which is not captured by the IR yield curve, such as borrow cost term structure. If the yield curve is supposed to be the term structure of the asset itself, I think passing the forward is redundant if spot and yield curve are already passed. – Daneel Olivaw Oct 15 '21 at 13:01
  • @DaneelOlivaw it's the pure interest rate. Why is e.g. the borrow cost term structure relevant for derivatives pricing? Could you suggest literature so I can read up on that? – algebruh Oct 15 '21 at 13:04
  • Suppose your asset is a stock, then in order to hedge the exotic derivative the market maker needs to borrow/lend dynamically the underlying asset, and that has a cost which is normally not the risk free rate. The forward price should encapsulate the borrow cost (think of your usual arbitrage argument for determining the forward price, if you introduce borrow cost at a rate $b$ then you can easily demonstrate the forward price now depends on that rate). Forward price also captures divident rate too. – Daneel Olivaw Oct 15 '21 at 13:11
  • @DaneelOlivaw Dividends are included. But I guess you are right. That is maybe it. Is this called FVA? – algebruh Oct 15 '21 at 13:14

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