The Curious Case of Backward Short Rates

15 Pages Posted: 20 Jan 2021 Last revised: 16 Mar 2021

See all articles by Andrei Lyashenko

Andrei Lyashenko

Quantitative Risk Management, Inc.

Yutian Nie

Quantitative Risk Management, Inc.

Date Written: November 11, 2020

Abstract

In this paper, we discuss how to discretize continuous-time short rate models in order to properly handle backward-looking interest rate derivatives. We show that the popular discretization approaches are based on forward-looking one-period rates, making them intrinsically ill-suited to deal with backward-looking rates. We propose a simple backward discretization approach that is beneficial when dealing with both backward-looking and forward-looking interest rate derivatives.

Keywords: IBOR Replacement, RFR, Short Rate Models, Backward-Looking Rates

JEL Classification: C22, C60, G12, G13

Suggested Citation

Lyashenko, Andrei and Nie, Yutian, The Curious Case of Backward Short Rates (November 11, 2020). Available at SSRN: https://ssrn.com/abstract=3728873 or http://dx.doi.org/10.2139/ssrn.3728873

Andrei Lyashenko (Contact Author)

Quantitative Risk Management, Inc. ( email )

181 W. Madison St
Chicago, IL 60602
United States

Yutian Nie

Quantitative Risk Management, Inc. ( email )

181 W. Madison St
Chicago, IL 60602
United States

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