International Business Machines Corp. unveiled last week what it claims is an innovative technology that allows investment firms to price derivatives more accurately.
Traders can use the calculation software tool to arrive at theoretical values for collateralized mortgage obligations, interest rate swaps, and other complex derivatives much faster than existing systems used on Wall Street, IBM officials said.
"This is one of the most significant breakthroughs in trading analytics in many years," said Robert Howe, general manager of IBM's banking, finance, and securities business unit. "IBM's contribution will allow securities firms to make better trades and to make more of them."
The new technology is primarily the result of more than 10 years of research by two IBM mathematicians, Dr. Shu Tezuka and Dr. Xiaolu Wang, based in Tokyo and New York respectively. The two researchers discovered a new way for calculating a derivative instrument's market value by using a mathematical technique called "deterministic simulation."
Banks currently use a financial modeling tool called "Monte Carlo simulation" in their trading analysis systems to help price their derivatives portfolios, but this approach has had its drawbacks, said Todd Hovanyecz, director of IBM's Mathematical and Analytics Center located in Manhattan's financial district.
"Monte Carlo simulation is easy to use on a variety of problems, but it can be painfully slow," Mr. Hovanyecz said. He added that deterministic simulation theory has been around for a number of years, but was considered an unwieldy tool until the two mathematicians refined it.
Now with the use of IBM's software, called the Deterministic Simulation Blaster, traders can price an interest rate swap in seconds instead of the hours it takes using the Monte Carlo technique, Mr. Hovanyecz said. "Traders should be able to price more accurately, and therefore the (derivatives) markets should become more liquid and less risky."
IBM officials said they intend to keep the details of its software proprietary, but it has begun to show the new calculation tool to academics and some of its Wall Street clients.
The Deterministic Simulation Blaster will be marketed to financial institutions as part of package of software, consulting, and systems integration services so firms can incorporate the model into their existing derivatives portfolio management systems.
The software was developed on IBM's RS/6000 line of computers, but it can be modified run on non-IBM hardware as well, Mr. Hovanyecz said.
The cost to install the system will likely be under a million dollars for each firm, said James McGill Jr., director of capital markets at IBM.