The Price-Rate Duality: Theory of Basis Spreads

10 Pages Posted: 11 Aug 2012 Last revised: 11 Sep 2012

See all articles by Eulogio Yustas

Eulogio Yustas

Model Risk Internal Audit, Banco Santander; Banco Santander - Boadilla del Monte

Date Written: August 10, 2012

Abstract

After the Subprime Crisis of 2007, basis spreads quoted for swaps and cross currency swaps rose. Until that moment, these spreads could be considered negligible from a pricing point of view and, as a consequence of this, valuation systems did not include these spreads as relevant variables. However, for as long as the size of these spreads did not return to the previous level, their impact in pricing had to be considered. The most standard model consists in the substitution of the interest rate curve by several rate curves depending on: either the tenors in order to estimate their forwards (for pricing basis swaps), or the currency chosen as local currency in order to estimate discount factors (for pricing cross currency swaps). The model proposed in this paper postulates the existence of a Price-Rate duality in the swap market in order to get a deeper understanding of this phenomenon. Furthermore, this model establishes a new way of reducing the number of curves that the multi-curve model needs.

Keywords: Discounting, Swap, Basis, Basis Swap, Valuation, Counterparty Risk, Collateral, EONIA, OIS, multiple tenors, closed form formulas

Suggested Citation

Yustas, Eulogio and Yustas, Eulogio, The Price-Rate Duality: Theory of Basis Spreads (August 10, 2012). Available at SSRN: https://ssrn.com/abstract=2127661 or http://dx.doi.org/10.2139/ssrn.2127661

Eulogio Yustas (Contact Author)

Banco Santander - Boadilla del Monte ( email )

Ciudad Financiera Grupo Santander
Avenida de Cantabria s/n
Boadilla del Monte, Madrid 28660
Spain

Model Risk Internal Audit, Banco Santander ( email )

Ciudad Financiera Grupo Santander
Avenida de Cantabria s/n
Boadilla del Monte, Madrid 28660
Spain

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
239
Abstract Views
1,194
Rank
229,204
PlumX Metrics