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This page intentionally left blank
 C++ DESIGN PATTERNS AND DERIVATIVES PRICING
2nd edition

Design patterns are the cutting-edge paradigm for programming in object-oriented lan-
guages. Here they are discussed in the context of implementing financial models in C++.
Assuming only a basic knowledge of C++ and mathematical finance, the reader is taught
how to produce well-designed, structured, reusable code via concrete examples.
This new edition includes several new chapters describing how to increase robustness
in the presence of exceptions, how to design a generic factory, how to interface C++
with EXCEL, and how to improve code design using the idea of decoupling. Complete
ANSI/ISO compatible C++ source code is hosted on an accompanying website for the
reader to study in detail, and reuse as they see fit.
A good understanding of C++ design is a necessity for working financial mathemati-
cian; this book provides a thorough introduction to the topic.
Mathematics, Finance and Risk

Editorial Board

Mark Broadie, Graduate School of Business, Columbia University

Sam Howison, Mathematical Institute, University of Oxford
Neil Johnson, Centre for Computational Finance, University of Oxford
George Papanicolaou, Department of Mathematics, Stanford University
C++ DESIGN PATTERNS AND
D E R I VA T I V E S P R I C I N G

M. S. J O S H I
University of Melbourne
CAMBRIDGE UNIVERSITY PRESS
Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo

Cambridge University Press

The Edinburgh Building, Cambridge CB2 8RU, UK
Published in the United States of America by Cambridge University Press, New York
www.cambridge.org
Information on this title: www.cambridge.org/9780521721622

© M. S. Joshi 2008

This publication is in copyright. Subject to statutory exception and to the provision of

relevant collective licensing agreements, no reproduction of any part may take place
without the written permission of Cambridge University Press.
First published in print format 2008

ISBN-13 978-0-511-39693-9 eBook (NetLibrary)

ISBN-13 978-0-521-72162-2 paperback

Cambridge University Press has no responsibility for the persistence or accuracy of urls
for external or third-party internet websites referred to in this publication, and does not
guarantee that any content on such websites is, or will remain, accurate or appropriate.
To Jane
 Contents

Preface page xiii

Acknowledgements xvi
1 A simple Monte Carlo model 1
1.1 Introduction 1
1.2 The theory 1
1.3 A simple implementation of a Monte Carlo call
option pricer 2
1.4 Critiquing the simple Monte Carlo routine 7
1.5 Identifying the classes 9
1.6 What will the classes buy us? 10
1.7 Why object-oriented programming? 11
1.8 Key points 11
1.9 Exercises 12
2 Encapsulation 13
2.1 Implementing the pay-off class 13
2.2 Privacy 15
2.3 Using the pay-off class 16
2.4 Further extensibility defects 19
2.5 The open–closed principle 20
2.6 Key points 21
2.7 Exercises 22
3 Inheritance and virtual functions 23
3.1 ‘is a’ 23
3.2 Coding inheritance 24
3.3 Virtual functions 24
3.4 Why we must pass the inherited object by reference 29
3.5 Not knowing the type and virtual destruction 30
3.6 Adding extra pay-offs without changing files 34

vii
viii Contents

3.7 Key points 37

3.8 Exercises 37
4 Bridging with a virtual constructor 38
4.1 The problem 38
4.2 A first solution 39
4.3 Virtual construction 43
4.4 The rule of three 51
4.5 The bridge 53
4.6 Beware of new 57
4.7 A parameters class 58
4.8 Key points 65
4.9 Exercises 65
5 Strategies, decoration, and statistics 66
5.1 Differing outputs 66
5.2 Designing a statistics gatherer 66
5.3 Using the statistics gatherer 69
5.4 Templates and wrappers 73
5.5 A convergence table 77
5.6 Decoration 80
5.7 Key points 81
5.8 Exercises 81
6 A random numbers class 83
6.1 Why? 83
6.2 Design considerations 84
6.3 The base class 86
6.4 A linear congruential generator and the adapter pattern 88
6.5 Anti-thetic sampling via decoration 93
6.6 Using the random number generator class 97
6.7 Key points 102
6.8 Exercises 102
7 An exotics engine and the template pattern 103
7.1 Introduction 103
7.2 Identifying components 104
7.3 Communication between the components 105
7.4 The base classes 106
7.5 A Black–Scholes path generation engine 111
7.6 An arithmetic Asian option 115
7.7 Putting it all together 117
7.8 Key points 120
7.9 Exercises 120
 Contents ix

8 Trees 121
8.1 Introduction 121
8.2 The design 123
8.3 The TreeProduct class 125
8.4 A tree class 129
8.5 Pricing on the tree 135
8.6 Key points 139
8.7 Exercises 139
9 Solvers, templates, and implied volatilities 141
9.1 The problem 141
9.2 Function objects 142
9.3 Bisecting with a template 145
9.4 Newton–Raphson and function template
arguments 149
9.5 Using Newton–Raphson to do implied
volatilities 151
9.6 The pros and cons of templatization 154
9.7 Key points 156
9.8 Exercises 156
10 The factory 157
10.1 The problem 157
10.2 The basic idea 157
10.3 The singleton pattern 158
10.4 Coding the factory 159
10.5 Automatic registration 162
10.6 Using the factory 165
10.7 Key points 166
10.8 Exercises 167
11 Design patterns revisited 168
11.1 Introduction 168
11.2 Creational patterns 168
11.3 Structural patterns 169
11.4 Behavioural patterns 170
11.5 Why design patterns? 171
11.6 Further reading 172
11.7 Key points 172
11.8 Exercise 173
12 The situation in 2007 174
12.1 Introduction 174
12.2 Compilers and the standard library 174
12.3 Boost 176
x Contents

12.4 QuantLib 177

12.5 xlw 177
12.6 Key points 178
12.7 Exercises 178
13 Exceptions 179
13.1 Introduction 179
13.2 Safety guarantees 180
13.3 The use of smart pointers 180
13.4 The rule of almost zero 183
13.5 Commands to never use 184
13.6 Making the wrapper class exception safe 185
13.7 Throwing in special functions 186
13.8 Floating point exceptions 187
13.9 Key points 192
14 Templatizing the factory 197
14.1 Introduction 197
14.2 Using inheritance to add structure 197
14.3 The curiously recurring template pattern 199
14.4 Using argument lists 200
14.5 The private part of the ArgumentList class 206
14.6 The implementation of the ArgumentList 208
14.7 Cell matrices 220
14.8 Cells and the ArgumentLists 224
14.9 The template factory 232
14.10 Using the templatized factory 237
14.11 Key points 242
14.12 Exercises 243
15 Interfacing with EXCEL 244
15.1 Introduction 244
15.2 Usage 245
15.3 Basic data types 247
15.4 Extended data types 248
15.5 xlw commands 250
15.6 The interface file 250
15.7 The interface generator 253
15.8 Troubleshooting 254
15.9 Debugging with xlls 254
15.10 Key points 255
15.11 Exercises 255
 Contents xi

16 Decoupling 256
16.1 Introduction 256
16.2 Header files 256
16.3 Splitting files 259
16.4 Direction of information flow and levelization 260
16.5 Classes as insulators 262
16.6 inlining 262
16.7 Template code 263
16.8 Functional interfaces 264
16.9 Pimpls 264
16.10 Key points 265
16.11 Exercises 265
Appendix A Black–Scholes formulas 266
Appendix B Distribution functions 270
Appendix C A simple array class 274
C.1 Choosing an array class 274
C.2 A simple array class 275
C.3 A simple array class 278
Appendix D The code 285
D.1 Using the code 285
D.2 Compilers 285
D.3 License 285
Appendix E Glossary 286
Bibliography 287
Index 289
 Preface

This book is aimed at a reader who has studied an introductory book on mathemat-
ical finance and an introductory book on C++ but does not know how to put the
two together. My objective is to teach the reader not just how to implement models
in C++ but more importantly how to think in an object-oriented way. There are
already many books on object-oriented programming; however, the examples tend
not to feel real to the financial mathematician so in this book we work exclusively
with examples from derivatives pricing.
We do not attempt to cover all sorts of financial models but instead examine a
few in depth with the objective at all times of using them to illustrate certain OO
ideas. We proceed largely by example, rewriting, our designs as new concepts are
introduced, instead of working out a great design at the start. Whilst this approach
is not optimal from a design standpoint, it is more pedagogically accessible. An
aspect of this is that our examples are designed to emphasize design principles
rather than to illustrate other features of coding, such as numerical efficiency or
exception safety.
We commence by introducing a simple Monte Carlo model which does not use
OO techniques but rather is the simplest procedural model for pricing a call option
one could write. We examine its shortcomings and discuss how classes naturally
arise from the concepts involved in its construction.
In Chapter 2, we move on to the concept of encapsulation – the idea that a class
allows to express a real-world analogue and its behaviours precisely. In order to
illustrate encapsulation, we look at how a class can be defined for the pay-off of a
vanilla option. We also see that the class we have defined has certain defects, and
this naturally leads on to the open–closed principle.
In Chapter 3, we see how a better pay-off class can be defined by using inheri-
tance and virtual functions. This raises technical issues involving destruction and
passing arguments, which we address. We also see how this approach is compatible
with the open–closed principle.

xiii
xiv Preface

Using virtual functions causes problems regarding the copying of objects of un-
known type, and in Chapter 4 we address these problems. We do so by introducing
virtual constructors and the bridge pattern. We digress to discuss the ‘rule of three’
and the slowness of new. The ideas are illustrated via a vanilla options class and a
parameters class.
With these new techniques at our disposal, we move on to looking at more com-
plicated design patterns in Chapter 5. We first introduce the strategy pattern that
expresses the idea that decisions on part of an algorithm can be deferred by dele-
gating responsibilities to an auxiliary class. We then look at how templates can be
used to write a wrapper class that removes a lot of our difficulties with memory
handling. As an application of these techniques, we develop a convergence table
using the decorator pattern.
In Chapter 6, we look at how to develop a random numbers class. We first exam-
ine why we need a class and then develop a simple implementation which provides
a reusable interface and an adequate random number generator. We use the imple-
mentation to introduce and illustrate the adapter pattern, and to examine further the
decorator pattern.
We move on to our first non-trivial application in Chapter 7, where we use the
classes developed so far in the implementation of a Monte Carlo pricer for path-
dependent exotic derivatives. As part of this design, we introduce and use the tem-
plate pattern. We finish with the pricing of Asian options.
We shift from Monte Carlo to trees in Chapter 8. We see the similarities and
differences between the two techniques, and implement a reusable design. As part
of the design, we reuse some of the classes developed earlier for Monte Carlo.
We return to the topic of templates in Chapter 9. We illustrate their use by design-
ing reusable solver classes. These classes are then used to define implied volatility
functions. En route, we look at function objects and pointers to member functions.
We finish with a discussion of the pros and cons of templatization.
In Chapter 10, we look at our most advanced topic: the factory pattern. This
patterns allows the addition of new functionality to a program without changing
any existing files. As part of the design, we introduce the singleton pattern.
We pause in Chapter 11 to classify, summarize, and discuss the design patterns
we have introduced. In particular, we see how they can be divided into creational,
structural, and behavioural patterns. We also review the literature on design patterns
to give the reader a guide for further study.
The final four chapters are new for the second edition. In these our focus is
different: rather than focussing exclusively on design patterns, we look at some
other important aspects of good coding that neophytes to C++ tend to be unaware
of.
 Preface xv

In Chapter 12, we take a historical look at the situation in 2007 and at what has
changed in recent years both in C++ and the financial engineering community’s
use of it.
The study of exception safety is the topic of Chapter 13. We see how making the
requirement that code functions well in the presence of exceptions places a large
number of constraints on style. We introduce some easy techniques to deal with
these constraints.
In Chapter 14, we return to the factory pattern. The original factory pattern re-
quired us to write similar code every time we introduced a new class hierarchy; we
now see how, by using argument lists and templates, a fully general factory class
can be coded and reused forever.
In Chapter 15, we look at something rather different that is very important in
day-to-day work for a quant: interfacing with EXCEL. In particular, we examine
the xlw package for building xlls. This package contains all the code necessary to
expose a C++ function to EXCEL, and even contains a parser to write the new
code required for each function.
The concept of physical design is introduced in Chapter 16. We see how the
objective of reducing compile times can affect our code organization and design.
The code for the examples in the first 11 chapters of this book can be freely
downloaded from www.markjoshi.com/design, and any bugfixes will be posted
there. The code for the remaining chapters is taken from the xlw project and can
be downloaded from xlw.sourceforge.net. All example code is taken from
release 2.1.
 Acknowledgements

I am grateful to the Royal Bank of Scotland for providing a stimulating environ-

ment in which to learn, study and do mathematical finance. Most of my views on
coding C++ and financial modelling have been developed during my time work-
ing there. My understanding of the topic has been formed through daily discussions
with current and former colleagues including Chris Hunter, Peter Jäckel, Dhermin-
der Kainth, Sukhdeep Mahal, Robin Nicholson and Jochen Theis. I am also grate-
ful to a host of people for their many comments on the manuscript, including Alex
Barnard, Dherminder Kainth, Rob Kitching, Sukhdeep Mahal, Nadim Mahassen,
Hugh McBride, Alan Stacey and Patrik Sundberg. I would also like to thank David
Tranah and the rest of the team at Cambridge University Press for their careful
work and attention to detail. Finally my wife has been very supportive.
I am grateful to a number of people for their comments on the second edi-
tion, with particular thanks to Chris Beveridge, Narinder Claire, Nick Denson and
Lorenzo Liesch.

xvi
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