The Irony in the Derivatives Discounting
Wilmott Magazine, pp. 92-98, July 2007
Posted: 25 Feb 2009
Date Written: July 1, 2007
A simple and fundamental question in derivatives pricing is how (contingent) cash-flows should be discounted. As cash can generally not be invested at Libor, the Libor curve is probably not the right discounting curve, even for Libor derivatives. The impact on derivative pricing of changing the discounting curve is discussed. The pricing formulas for vanilla products are revisited in the funding framework described.
Keywords: Cost of funding, coherent pricing, interest rate derivative pricing, Libor, irony
JEL Classification: G13, E43, C63
Suggested Citation: Suggested Citation