The Making of Zero Curves

28 Pages Posted: 7 Sep 2021 Last revised: 2 Oct 2021

See all articles by Emilio Barone

Emilio Barone

Luiss - Guido Carli (Dpt. of Economics and Finance)

Gaia Barone

School of Business, National College of Ireland

Jeffrey C. Williams

University of California, Davis

Date Written: August 31, 2021

Abstract

Risk-free rates are ubiquitous in finance, even more after the Cox-Ross [6] principle of risk-neutral valuation for derivatives. Simple arbitrage shows that they can be negative only if considered net of the storage cost of money.

The phase-out of Libor, its replacement by overnight reference rates, and the way they are used to determine zero rates make this paper’s topic relevant.

Similarly to the federal funds rate, which is a weighted average of the rates in brokered transactions (with weights being determined by the size of the transaction), we advocate the construction of transaction-weighted zero curves. In particular, we highlight the role of risk-free zero curves defined by the ISDA CDS standard model in order to standardize the quotes in the market for credit default swaps.

Keywords: Credit, banking, risk management

JEL Classification: G12

Suggested Citation

Barone, Emilio and Barone, Gaia and Williams, Jeffrey C., The Making of Zero Curves (August 31, 2021). Available at SSRN: https://ssrn.com/abstract=3917904 or http://dx.doi.org/10.2139/ssrn.3917904

Emilio Barone (Contact Author)

Luiss - Guido Carli (Dpt. of Economics and Finance) ( email )

Viale Romania, 32
Rome, 00197
Italy

HOME PAGE: http://docenti.luiss.it/barone/

Gaia Barone

School of Business, National College of Ireland ( email )

Mayor Street
IFSC
Dublin, 1
Ireland

Jeffrey C. Williams

University of California, Davis ( email )

One Shields Avenue
Apt 153
Davis, CA 95616
United States

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