Dividend Yields: More Transparent Pricing of Equity Index Derivatives

by Lucido Group

Dividends on equity index derivatives are typically captured as a continuously compounded yield, with a different yield over a forecast horizon, to create a term structure of dividend yields. The dividend yield has a significant impact on the pricing of equity index derivatives.

Dividends on equity indices are saved in a dedicated Dividends Manager window in Findur. In another paper that we recommend you read, we described the catalog of problems with the Dividend Manager window.

This paper showcases an enhancement that improves the transparency of pricing of equity index derivatives, specifically related to the dividend yields.

It is difficult in Findur for users to see the dividend yield affecting a portfolio of equity index derivatives. It is impossible to see the historical dividend yields used during a prior day, month-end or year-end. All users in the front-office to the back, not to mention auditors, should be concerned about the degree of opacity of equity derivative pricing.

We have a simple solution that uncovers the dividends that were used during a particular portfolio revaluation. The solution is a General class of simulation result that saves the yields for the user to review. If there is a pricing discrepancy, it might be the result of a problem with dividends. This solution will make it easier to identify dividends as the source of a pricing problem.

This screenshot displays the term structure of continuously compounded dividend yields on the CIISDA5N index. The start date and end date fields show the yield for a subset of the horizon.

Dividend Pricing Transparency: Dividend Yield Simulation Result

As a simulation result, these results are available for selection in end-of-day or intraday ad-hoc simulation runs. It is easy to configure a Report Builder definition to review dividend history for a given day, or a period of many days. It is easy to extract the results to a data warehouse.

While we would advocate for an enhancement to the capture, storage, maintenance and transparency of dividends on equity index derivatives, until that happens, this solution improves pricing controls, supporting users all the way from the front-office to the back-office.