Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2014. The project is a required component of every master program.
Interest rates after the credit crunch crisis: single versus multiple curve approach
Oleksandr Dmytriiev, Yining Geng, and Cem Sinan Ozturk
For interest rate derivative pricing, 2007 crisis was a turning point. Prior to the crisis, market interest rates showed consistencies that allowed the use of a single curve for both forwarding and discounting. After the crisis, the inconsistencies in the market interest rates led to development of a new method of the pricing interest rate derivatives, which is called Multi-Curve Framework. We studied the influence of the multi-curve approach on the interest rate derivative pricing. We calculated and compared the price of a simple swap in both multi-curve and single curve approaches. We suggested the generalization of the lattice approach, which is usually used to approximate the short interest rate models, for milti-curve framework. This is a novel result, which have not been developed in the scientific literature. As an example, we showed how to use the Black-Derman-Toy interest rate model on binomial lattice in multi-curve framework and calculated the price of the 2-8 period swaption in a single (LIBOR) curve and two-curve (OIS+LIBOR) approaches. This technique can be used for pricing any interest rate instrument.
Read the full paper or view slides below: