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Continuous tenor extension of affine LIBOR models with multiple curves and applications to XVA

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  • Antonis Papapantoleon
  • Robert Wardenga

Abstract

We consider the class of affine LIBOR models with multiple curves, which is an analytically tractable class of discrete tenor models that easily accommodates positive or negative interest rates and positive spreads. By introducing an interpolating function, we extend the affine LIBOR models to a continuous tenor and derive expressions for the instantaneous forward rate and the short rate. We show that the continuous tenor model is arbitrage-free, that the analytical tractability is retained under the spot martingale measure, and that under mild conditions an interpolating function can be found such that the extended model fits any initial forward curve. This allows us to compute value adjustments (i.e. XVAs) consistently, by solving the corresponding `pre-default' BSDE. As an application, we compute the price and value adjustments for a basis swap, and study the model risk associated to different interpolating functions.

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  • Antonis Papapantoleon & Robert Wardenga, 2016. "Continuous tenor extension of affine LIBOR models with multiple curves and applications to XVA," Papers 1607.03522, arXiv.org, revised Feb 2017.
    • Handle: RePEc:arx:papers:1607.03522
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    1. Zorana Grbac & Antonis Papapantoleon & John Schoenmakers & David Skovmand, 2014. "Affine LIBOR models with multiple curves: theory, examples and calibration," Papers 1405.2450, arXiv.org, revised Aug 2015.
    2. Marek Rutkowski & Marek Musiela, 1997. "Continuous-time term structure models: Forward measure approach (*)," Finance and Stochastics, Springer, vol. 1(4), pages 261-291.
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