Proving the Market Observability of Derivatives and Consensus

Totem Trade Data Services: Transaction/ quote analytics and reporting for derivatives markets, including Totem consensus scoring and back testing, liquidity reports, analytics, and customized reporting for clients. Use cases include fair value leveling, day 1 P&L review, valuation adjustments, consensus assessment/scoring, concentration risk, liquidity risk, audit, and regulatory review.

The question: Is consensus pricing reflective of the market?

As global regulatory scrutiny increases on banks, the need to substantiate independent valuation decisions has also grown. Valuation control groups at banks across the globe use the Totem consensus data to independently verify derivative fair values across equities, rates, FX, commodities, and XVA. Totem consensus data provides the average of accepted prices from active market participants that submit their best estimates of mid market values across liquid and illiquid instruments. Given the nature of derivative markets and the consensus, not all points published are actively trading. So, how do you prove that the consensus accurately reflects the market?

The solution: Compare the consensus to transactions and executable quotes.

We use transactions and market color, such as executable quotes, to back test the consensus to prove that it accurately reflects the market. A large global bank (referred to as the “GSIB Bank”) and Totem worked together to create customized back testing logic for each asset class based on available market color and consensus fields.

The Bank applied the following customized back test to S&P Global Market Intelligence Trade Data:

− x = 𝑇𝑟𝑎𝑑𝑒 𝑃𝑟𝑖𝑐𝑒 − 𝐶𝑜𝑛𝑠𝑒𝑛𝑠𝑢𝑠 𝑃𝑟𝑖𝑐𝑒𝐶𝑜𝑛𝑠𝑒𝑛𝑠𝑢𝑠 𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝐷𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 + 𝑉𝑜𝑙𝑎𝑡𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝐶𝑜𝑛𝑠𝑒𝑛𝑠𝑢𝑠 𝑃𝑟𝑖𝑐𝑒

− If 𝑥 > 1 = Fail or if 𝑥 < 1 = Pass

− Consensus Standard Deviation is the same as published in the results file for the trade date of the trade being tested.

− Volatility of Consensus Price is calculated as the standard deviation of the consensus for the report look-back period (e.g., one month, three months, etc.)

This back testing approach shows the differences between trades and consensus in the context of price volatility and consensus volatility over that period, thereby isolating true variances in volatile markets. From the GSIB Bank’s perspective, “Totem’s price volatility based back-testing reports help our team operationally in a very significant way.”