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Fair prices under a unified lattice approach for interest rate derivatives

  • Giacomo MorelliEmail author
S.I. : Recent Developments in Financial Modeling and Risk Management
  • 6 Downloads

Abstract

An open question in interest rates derivative pricing is whether the price of the contracts should be computed by means of a multi-curve approach (different yield curves for discounting and forwarding) or by using a single curve (just one yield curve both for discounting and forwarding). The answer is of primary importance for financial markets as it allows to define a class of fair contracts. This paper calculates and compares the price of a simple swap within both multi-curve and single curve approaches and proposes a generalization of the lattice approach, which is usually used to approximate short interest rate models in the multi-curve framework. As an example, I show how to use the Black et al. (Financ Anal J 46(1):33–39, 1990) interest rate model on binomial lattice in multi-curve framework and calculate the price of the 2–8 period swaption with a single (LIBOR) curve and two-curve (OIS+LIBOR) approaches. Such technique can be used for pricing any interest rate based contract.

Keywords

Interest rates Single curve Multiple curve Derivative pricing Fair contracts 

JEL Classification

C02 C60 C63 

Notes

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Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2019

Authors and Affiliations

  1. 1.Department of Economics and FinanceLUISS UniversityRomeItaly

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