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A Market Model of Interest Rates with Dynamic Basis Spreads in the presence of Collateral and Multiple Currencies

Author

Listed:
  • Masaaki Fujii

    (Graduate School of Economics, University of Tokyo)

  • Yasufumi Shimada

    (Capital Markets Division, Shinsei Bank, Limited)

  • Akihiko Takahashi

    (Faculty of Economics, University of Tokyo)

Abstract

The recent financial crisis caused dramatic widening and elevated volatilities among basis spreads in cross currency as well as domestic interest rate markets. Furthermore, the wide spread use of cash collateral, especially in fixed income contracts, has made the effective funding cost of financial institutions for the trades significantly different from the Libor of the corresponding payment currency. Because of these market developments, the text-book style application of a market model of interest rates has now become inappropriate for financial firms; It cannot even reflect the exposures to these basis spreads in pricing, to say nothing of proper delta and vega (or kappa) hedges against their movements. This paper presents a new framework of the market model to address all these issues.

Suggested Citation

  • Masaaki Fujii & Yasufumi Shimada & Akihiko Takahashi, 2009. "A Market Model of Interest Rates with Dynamic Basis Spreads in the presence of Collateral and Multiple Currencies," CIRJE F-Series CIRJE-F-698, CIRJE, Faculty of Economics, University of Tokyo.
    • Handle: RePEc:tky:fseres:2009cf698
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    File URL: http://www.cirje.e.u-tokyo.ac.jp/research/dp/2009/2009cf698.pdf
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    References listed on IDEAS

    as
    1. Farshid Jamshidian, 1997. "LIBOR and swap market models and measures (*)," Finance and Stochastics, Springer, vol. 1(4), pages 293-330.
    2. Masaaki Fujii & Akihiko Takahashi, 2010. "Modeling of Interest Rate Term Structures under Collateralization and its Implications," CIRJE F-Series CIRJE-F-762, CIRJE, Faculty of Economics, University of Tokyo.
    3. Robert Jarrow & Yildiray Yildirim, 2008. "Pricing Treasury Inflation Protected Securities and Related Derivatives using an HJM Model," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 16, pages 349-370, World Scientific Publishing Co. Pte. Ltd..
    4. Masaaki Fujii & Akihiko Takahashi, 2010. "Asymmetric and Imperfect Collateralization, Derivative Pricing, and CVA," CIRJE F-Series CIRJE-F-781, CIRJE, Faculty of Economics, University of Tokyo.
    5. Marco Bianchetti, 2009. "Two Curves, One Price: Pricing & Hedging Interest Rate Derivatives Decoupling Forwarding and Discounting Yield Curves," Papers 0905.2770, arXiv.org, revised Jul 2012.
    6. Masaaki Fujii & Yasufumi Shimada & Akihiko Takahashi, 2009. "A Note on Construction of Multiple Swap Curves with and without Collateral," CIRJE F-Series CIRJE-F-630, CIRJE, Faculty of Economics, University of Tokyo.
    7. Patrick Hagan & Graeme West, 2006. "Interpolation Methods for Curve Construction," Applied Mathematical Finance, Taylor & Francis Journals, vol. 13(2), pages 89-129.
    8. Masaaki Fujii & Akihiko Takahashi, 2010. "Modeling of Interest Rate Term Structures under Collateralization and its Implications," CARF F-Series CARF-F-230, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo, revised Dec 2010.
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    Cited by:

    1. Masaaki Fujii & Akihiko Takahashi, 2011. "Collateralized CDS and Default Dependence -Implications for the Central Clearing-," CIRJE F-Series CIRJE-F-799, CIRJE, Faculty of Economics, University of Tokyo.
    2. Masaaki Fujii & Akihiko Takahashi, 2011. "Derivative Pricing under Asymmetric and Imperfect Collateralization and CVA," CARF F-Series CARF-F-265, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    3. Yang Chang, 2014. "A Consistent Approach to Modelling the Interest Rate Market Anomalies Post the Global Financial Crisis," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 18, July-Dece.
    4. Masaaki Fujii & Akihiko Takahashi, 2010. "Asymmetric and Imperfect Collateralization, Derivative Pricing, and CVA," CIRJE F-Series CIRJE-F-781, CIRJE, Faculty of Economics, University of Tokyo.
    5. Masaaki Fujii & Yasufumi Shimada & Akihiko Takahashi, 2010. "Collateral Posting and Choice of Collateral Currency - Implications for Derivative Pricing and Risk Management-," CIRJE F-Series CIRJE-F-743, CIRJE, Faculty of Economics, University of Tokyo.
    6. Yang Chang, 2014. "A Consistent Approach to Modelling the Interest Rate Market Anomalies Post the Global Financial Crisis," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 2-2014.
    7. Masaaki Fujii & Akihiko Takahashi, 2010. "Derivative Pricing under Asymmetric and Imperfect Collateralization and CVA," CARF F-Series CARF-F-240, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo, revised Mar 2011.
    8. Guillermo Andrés Cangrejo Jiménez, 2014. "La Estructura a Plazos del Riesgo Interbancario," Documentos de Trabajo 12172, Universidad del Rosario.
    9. Yang Chang & Erik Schlogl, 2014. "A Consistent Framework for Modelling Basis Spreads in Tenor Swaps," Research Paper Series 348, Quantitative Finance Research Centre, University of Technology, Sydney.
    10. Masaaki Fujii & Yasufumi Shimada & Akihiko Takahashi, 2010. "Collateral Posting and Choice of Collateral Currency -Implications for Derivative Pricing and Risk Management-," CARF F-Series CARF-F-216, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    11. Masaaki Fujii & Akihiko Takahashi, 2012. "Derivative pricing under asymmetric and imperfect collateralization and CVA," Quantitative Finance, Taylor & Francis Journals, vol. 13(5), pages 749-768, October.
    12. Eduard Gim'enez & Alberto Elices & Giovanna Villani, 2014. "A heuristic pricing and hedging framework for multi-currency fixed income desks," Papers 1406.1811, arXiv.org, revised Jan 2017.
    13. Jean-Paul Laurent & Philippe Amzelek & Joe Bonnaud, 2014. "An overview of the valuation of collateralized derivative contracts," Review of Derivatives Research, Springer, vol. 17(3), pages 261-286, October.
    14. Masaaki Fujii & Akihiko Takahashi, 2010. "Modeling of Interest Rate Term Structures under Collateralization and its Implications," CARF F-Series CARF-F-230, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo, revised Dec 2010.
    15. Masaaki Fujii & Akihiko Takahashi, 2010. "Choice of Collateral Currency," CARF F-Series CARF-F-239, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    16. Filipović, Damir & Trolle, Anders B., 2013. "The term structure of interbank risk," Journal of Financial Economics, Elsevier, vol. 109(3), pages 707-733.
    17. Masaaki Fujii & Akihiko Takahashi, 2010. "Choice of Collateral Currency," CIRJE F-Series CIRJE-F-778, CIRJE, Faculty of Economics, University of Tokyo.
    18. Calice, Giovanni, 2011. "The Impact of Collateral Policies on Sovereign CDS Spreads," ECMI Papers 12234, Centre for European Policy Studies.
    19. Masaaki Fujii & Akihiko Takahashi, 2011. "Collateralized CDS and Default Dependence -Implications for the Central Clearing-," CARF F-Series CARF-F-246, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    20. Masaaki Fujii & Akihiko Takahashi, 2010. "Modeling of Interest Rate Term Structures under Collateralization and its Implications," CIRJE F-Series CIRJE-F-762, CIRJE, Faculty of Economics, University of Tokyo.
    21. Masaaki Fujii & Akihiko Takahashi, 2012. "Collateralized CDS and Default Dependence -Implications for the Central Clearing," CARF F-Series CARF-F-281, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.

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