Abstract

http://ssrn.com/abstract=1783798
 
 

Citations (1)



 


 



Central Clearing of Interest Rate Swaps: A Comparison of Offerings


Rama Cont


Imperial College London; CNRS - Universite de Paris VI

Radu Paul Mondescu


DRW Trading Group

Yuhua Yu


DRW Trading Group

March 11, 2011


Abstract:     
Regulatory changes have motivated the development of a variety of solutions for the clearing of interest rate swaps. Margin payments associated with clearing lead to modifications in cash flows which result in differences in the valuation between cleared and non-cleared swaps. We propose a framework for computing these differences and show that they lead to two types of modifications in contract value: a convexity effect and a “Net Present Value” (NPV) effect, which can be significant for long-dated swaps. As a result, modifications in contract design are required in order for a centrally cleared interest rate swap to be economically equivalent to its uncleared counterpart. Among the currently available offerings for cleared interest rate swaps, three offerings are shown to be economically equivalent to their uncleared counterparts – the “Price Alignment Interest” method used by LCH. Clearnet and CME, as well as a new adjustment method used by the Eris Exchange – while a fourth method, used in the IDCG swap futures contract, is shown to lead to substantial deviations in valuation with respect to a non-cleared interest rate swap. Using a Hull-White model calibrated to the market data as of December 2010, we find the difference between the IDCG futures swap rate and the corresponding uncleared swap rate to be around 18 basis points for a 10 year contract and about 60 basis points for a 30 year contract. An interest rate environment with higher volatility will result in larger differences.

Number of Pages in PDF File: 25

Keywords: interest rate swap, central clearing, convexity, swap futures, price alignment interest, net present value effect

JEL Classification: G13, G20

working papers series





Download This Paper

Date posted: March 14, 2011  

Suggested Citation

Cont, Rama and Mondescu, Radu Paul and Yu, Yuhua, Central Clearing of Interest Rate Swaps: A Comparison of Offerings (March 11, 2011). Available at SSRN: http://ssrn.com/abstract=1783798 or http://dx.doi.org/10.2139/ssrn.1783798

Contact Information

Rama Cont
Imperial College London ( email )
London, SW7 2AZ
United Kingdom
HOME PAGE: http://www3.imperial.ac.uk/people/r.cont
CNRS - Universite de Paris VI ( email )
Laboratoire de Probabilites & Modeles aleatoires
Universite Pierre & Marie Curie (Paris VI)
Paris, 75252
France
HOME PAGE: http://www.proba.jussieu.fr/pageperso/ramacont/
Radu P. Mondescu
DRW Trading Group ( email )
540 W. Madison Street
Suite 2500
Chicago, IL 60661
United States
HOME PAGE: http://www.drwtrading.com/
Yuhua Yu (Contact Author)
DRW Trading Group ( email )
540 W. Madison Street
Suite 2500
Chicago, IL 60661
United States
Feedback to SSRN


Paper statistics
Abstract Views: 6,053
Downloads: 1,403
Download Rank: 6,635
Citations:  1

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo7 in 0.844 seconds