Swap Valuation with Dual Curves - Approximations

Abstract

For the case of single-curve (libor) valuation it is well-known that receiving fixed on a swap is equivalent to long a fixed coupon bond and short a floating bond. This equivalence shows us how the swap behaves and can be used (together with at-market swap rates and yield-tomaturity formulae) as an approximation for valuation and risk (DV01). In the past few years, however, markets have moved to dual-curve valuation – cash flows are projected with the libor curve but discounted off the OIS (Fed Funds) curve. The usual equivalence no longer applies. We can, however, develop an alternative equivalence and approximation by adjusting the swap coupon and the discounting yield by the libor/OIS spread. This provides an approximation for valuation and risk (DV01) that is useful in practice and provides valuable insights into single-curve versus dual-curve valuation and risk.

Keywords: Swap Valuation Dual-Curve OIS

JEL Classification: G10, G12, G13