On the Term Structure of Interest Rates with Basis Spreads, Collateral and Multiple Currencies
University of Tokyo - Faculty of Economics
Shinsei Bank, Ltd
University of Tokyo - Graduate School of Economics
February 18, 2010
The recent financial crisis caused dramatic widening and elevated volatilities among basis spreads in cross currency as well as domestic interest rate markets. Furthermore, the widespread use of collateral has made the effective funding cost of financial institutions for the trades significantly different from the Libor of the corresponding payment currency. In this presentation, after reviewing the implications of profit/loss for financial firms still using a textbook-style curve construction and an interest rate model, we will explain the consistent swap curve construction with all the basis spreads taken into account, and how to make all the reference rates stochastic with no-arbitrage conditions.
Number of Pages in PDF File: 75
Keywords: Libor, Swap, Tenor, Yield Curve, Collateral, Overnight Index Swap, Cross Currency, Basis Spread, Market Model, HJM
JEL Classification: E43,G13
Date posted: February 21, 2010 ; Last revised: March 23, 2010
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