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Fair prices under a unified lattice approach for interest rate derivatives

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  • Giacomo Morelli

    (LUISS University)

Abstract

An open question in interest rates derivative pricing is whether the price of the contracts should be computed by means of a multi-curve approach (different yield curves for discounting and forwarding) or by using a single curve (just one yield curve both for discounting and forwarding). The answer is of primary importance for financial markets as it allows to define a class of fair contracts. This paper calculates and compares the price of a simple swap within both multi-curve and single curve approaches and proposes a generalization of the lattice approach, which is usually used to approximate short interest rate models in the multi-curve framework. As an example, I show how to use the Black et al. (Financ Anal J 46(1):33–39, 1990) interest rate model on binomial lattice in multi-curve framework and calculate the price of the 2–8 period swaption with a single (LIBOR) curve and two-curve (OIS+LIBOR) approaches. Such technique can be used for pricing any interest rate based contract.

Suggested Citation

  • Giacomo Morelli, 2021. "Fair prices under a unified lattice approach for interest rate derivatives," Annals of Operations Research, Springer, vol. 299(1), pages 429-441, April.
    • Handle: RePEc:spr:annopr:v:299:y:2021:i:1:d:10.1007_s10479-019-03209-y
    DOI: 10.1007/s10479-019-03209-y
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    References listed on IDEAS

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    Cited by:

    1. Taiga Saito & Shivam Gupta, 2022. "Big Data Applications with Theoretical Models and Social Media in Financial Management," CIRJE F-Series CIRJE-F-1205, CIRJE, Faculty of Economics, University of Tokyo.
    2. Taiga Saito & Shivam Gupta, 2022. "Big data applications with theoretical models and social media in financial management," CARF F-Series CARF-F-550, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.

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    More about this item

    Keywords

    Interest rates; Single curve; Multiple curve; Derivative pricing; Fair contracts;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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