The Irony in the Derivatives Discounting
Marc P. A. Henrard
OpenGamma; University College London - Department of Mathematics
A simple and fundamental question in derivatives pricing is the way (contingent) cash-flows should be discounted. As cash can not be invested at Libor the curve is probably not the right discounting curve, even for Libor derivatives. The impact on derivative pricing of changing the discounting curve is discussed. The pricing formulas for vanilla products are revisited in the funding framework described.
Number of Pages in PDF File: 10
Keywords: Cost of funding, coherent pricing, interest rate derivative pricing, Libor, irony.
JEL Classification: G13, E43, C63
Date posted: March 14, 2007