exotic derivative

{{Short description|Derivative which is more complex than commonly traded products}}

class="wikitable" style="float: right; margin-left: 1em" |+Types of exotic derivative

*Energy derivative Freight derivative Inflation derivative Exotic interest rate option Macro derivative Weather derivative Property derivatives

An exotic derivative, in finance, is a derivative which is more complex than commonly traded "vanilla" products. This complexity usually relates to determination of payoff;{{cite web |url=http://www.garp.org/risk-news-and-resources/risk-glossary/risk-glossary.aspx?p=5 |title=GARP - Risk Glossary |website=www.garp.org |access-date=27 January 2022 |archive-url=https://archive.today/20130414190702/http://www.garp.org/risk-news-and-resources/risk-glossary/risk-glossary.aspx?p=5 |archive-date=14 April 2013 |url-status=dead}} see option style.

The category may also include derivatives with a non-standard subject matter - i.e., underlying - developed for a particular client or a particular market.[http://www.hmrc.gov.uk/manuals/cfmmanual/cfm11095.htm Understanding derivative contracts: types of derivatives] {{webarchive |url=https://web.archive.org/web/20120115201009/http://www.hmrc.gov.uk/manuals/cfmmanual/cfm11095.htm |date=January 15, 2012 }}

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 using specialized simulation- or lattice-based techniques. Often, it is possible, to "manufacture" the exotic derivative out of standard derivatives.{{Cite web |url=http://www.ederman.com/new/docs/risk-markets_and_models.pdf |title=Emanuel Derman |access-date=2012-03-15 |archive-date=2012-03-12 |archive-url=https://web.archive.org/web/20120312170407/http://www.ederman.com/new/docs/risk-markets_and_models.pdf |url-status=dead }} For example, a knockout call can be "manufactured" out of standard options; see {{slink|Barrier option#Valuation}}. This latter approach may then be preferred, and also allows for a benchmark against which the more specialized models may be verified.