Derivative pricing for a multi-curve extension of the Gaussian, exponentially quadratic short rate model

DOI10.1007/978-3-319-33446-2_10zbMATH Open1398.91594arXiv1512.03259OpenAlexW2193986188MaRDI QIDQ4689909FDOQ4689909

Authors: Zorana Grbac, Laura Meneghello, Wolfgang J. Runggaldier 

Publication date: 22 October 2018

Published in: Innovations in Derivatives Markets (Search for Journal in Brave)

Abstract: The recent financial crisis has led to so-called multi-curve models for the term structure. Here we study a multi-curve extension of short rate models where, in addition to the short rate itself, we introduce short rate spreads. In particular, we consider a Gaussian factor model where the short rate and the spreads are second order polynomials of Gaussian factor processes. This leads to an exponentially quadratic model class that is less well known than the exponentially affine class. In the latter class the factors enter linearly and for positivity one considers square root factor processes. While the square root factors in the affine class have more involved distributions, in the quadratic class the factors remain Gaussian and this leads to various advantages, in particular for derivative pricing. After some preliminaries on martingale modeling in the multi-curve setup, we concentrate on pricing of linear and optional derivatives. For linear derivatives, we exhibit an adjustment factor that allows one to pass from pre-crisis single curve values to the corresponding post-crisis multi-curve values.

Full work available at URL: https://arxiv.org/abs/1512.03259

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zbMATH Keywords

Riccati equationsshort rate modelsmulti-curve modelsadjustment factorsGaussian exponentially quadratic modelspricing of linear and optional interest rate derivativesshort rate spreads

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Martingales with continuous parameter (60G44) Interest rates, asset pricing, etc. (stochastic models) (91G30)

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Cited In (4)

• Title not available (Why is that?)
• Arbitrage-free Nelson-Siegel model for multiple yield curves
• Back-of-the-envelope swaptions in a very parsimonious multi-curve interest rate model
• Multiple yield curve modelling with CBI processes

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