Interest-Rate Modelling in Collateralized Markets: Multiple Curves, Credit-Liquidity Effects, CCPs

25 Pages Posted: 4 Apr 2013

See all articles by Andrea Pallavicini

Andrea Pallavicini

Banca IMI; Imperial College London - Department of Mathematics

Damiano Brigo

Imperial College London - Department of Mathematics

Date Written: April 4, 2013

Abstract

The market practice of extrapolating different term structures from different instruments lacks a rigorous justification in terms of cash flows structure and market observables. In this paper, we integrate our previous consistent theory for pricing under credit, collateral and funding risks into term structure modelling, integrating the origination of different term structures with such effects. Under a number of assumptions on collateralization, wrong-way risk, gap risk, credit valuation adjustments and funding effects, including the treasury operational model, and via an immersion hypothesis, we are able to derive a synthetic master equation for the multiple term structure dynamics that integrates multiple curves with credit/funding adjustments.

Keywords: Yield Curve Dynamics, Multiple Curve Framework, HJM Framework, Interest Rate Derivatives, Basis Swaps, Counterparty Credit Risk, Liquidity Risk, Funding Costs, Central Clearing Counterparties

JEL Classification: G13

Suggested Citation

Pallavicini, Andrea and Brigo, Damiano, Interest-Rate Modelling in Collateralized Markets: Multiple Curves, Credit-Liquidity Effects, CCPs (April 4, 2013). Available at SSRN: https://ssrn.com/abstract=2244580 or http://dx.doi.org/10.2139/ssrn.2244580

Andrea Pallavicini (Contact Author)

Banca IMI ( email )

Largo Mattioli 3
Milan, MI 20121
Italy
+39 02 7261 (Phone)

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom

Damiano Brigo

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom

HOME PAGE: http://www.imperial.ac.uk/people/damiano.brigo

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