The Multi-Curve Potential Model
26 Pages Posted: 28 Sep 2014 Last revised: 3 Sep 2015
Date Written: August 24, 2015
We develop a general class of multi-curve potential models for post-crisis interest rates. Our model features positive stochastic basis spreads, positive term structures, and analytic pricing formulae for interest rate derivatives. Making a quanto interpretation of LIBOR lending transactions, we use a multi-currency analogy to model multiple term structures and formulate a general, tractable model of multiple term structures. As a special case of our approach, we obtain a rational lognormal model that extends the original Flesaker-Hughston (1996) rational lognormal model to a multi-curve setting. In this setting we obtain analytic pricing formulae for caps and swaptions.
Keywords: Multi-curve models, potential approach, state-price deflator, foreign exchange rates, rational lognormal model, OIS, LIBOR, FRA rate, FRA spread, LIBOR-OIS spread
JEL Classification: E43, G12, G13
Suggested Citation: Suggested Citation