This question is related to the discussion on Model Validation Criteria However it appeard to be very high level to me and I would like to go more into detail.
Not working at a pricing desk the following has always puzzled me: How are quants able to verify whether their calculated prices are any good? (by "calculated prices" I mean the ones output by some model - e.g. B&S, Heston )
One could perhaps distingusih the two:
- A priori
- A posteriori
I would assume a priory mainly consists of model choice (fitting the market data etc.) - Thus the A priori part is related to this question.
Alas, I am quite clueless what an a posteriori check would look like. What would be the benchmark one would check against ?