2015/07/31 by Giacomo Bormetti, Damiano Brigo, Bormetti, Giacomo +5
Economics, Econometrics and Finance · #60J75 #91B70 #Computational Finance (q-fin.CP) #Credit Risk and Financial Regulations #FOS: Economics and business #Pricing of Securities (q-fin.PR) #Stochastic processes and financial applications
paper · pdf · doi:10.48550/arxiv.1507.08779
openalex publication_date 2015/07/31 · openalex created_date 2022/10/06 · openalex updated_date 2026/07/28
We present a detailed analysis of interest rate derivatives valuation under\ncredit risk and collateral modeling. We show how the credit and collateral\nextended valuation framework in Pallavicini et al (2011), and the related\ncollateralized valuation measure, can be helpful in defining the key market\nrates underlying the multiple interest rate curves that characterize current\ninterest rate markets. A key point is that spot Libor rates are to be treated\nas market primitives rather than being defined by no-arbitrage relationships.\nWe formulate a consistent realistic dynamics for the different rates emerging\nfrom our analysis and compare the resulting model performances to simpler\nmodels used in the industry. We include the often neglected margin period of\nrisk, showing how this feature may increase the impact of different rates\ndynamics on valuation. We point out limitations of multiple curve models with\ndeterministic basis considering valuation of particularly sensitive products\nsuch as basis swaps. We stress that a proper wrong way risk analysis for such\nproducts requires a model with a stochastic basis and we show numerical results\nconfirming this fact.\n