Course description
Interest rate modelling has changed dramatically since the start of the financial crisis in 2007. Most of the derivative models used in academic literature and by practitioners have had to be reviewed in line with new regulatory requirements. One of the main changes is the mandatory variation margin (VM) regime that came into effect on 1st March 2017, which has established the collateralization of derivatives trades as the de facto standard. No reasonable derivative management and modeling can be done without taking the new dynamic and the regulatory aspects into account. Two frameworks have become the standard: the collateral discounting for the VM and the multi-curve framework for interest rate and, in particular, the differentiation between different underlying curves.
The first part of the program examines in detail the multi-curve and collateral framework foundations and the curve calibrations, including cross-currency aspects. Once the foundations are in place, the interest rate term structure stochastic modeling has also to be re-examined: the existing models have to be adapted and new versions created to take into account the collateral framework, including the stochastic basis between the different curves.
The course will also provide a perspective on the hidden complexity behind the expected changes to the main interest rate benchmarks and the proposal related to LIBOR fall-back.
Participants will review some of the alternative models and the impact of more advanced models on the pricing of vanilla interest rate products (IRS, OIS, FRA, basis swaps, Futures, swaptions, etc.). Practical workshops and examples use production grade open source code (the code is used by banks, CCPs, hedge funds), which participants can take away for immediate application.
All participants will also receive a copy of Dr Marc Henrard’s book “Interest rate modeling in the multi-curve framework: foundations, evolution, and implementation”.
Upcoming start dates
Training content
Day One
Pricing with collateral – Variation Margin
- Margin: terminology, fundamentals, and market infrastructure
- Regulatory framework for Variation Margin, CSA, time table
- Cash collateral and generalization. The cash-collateral discounting. The standard collateral results and their exact application. Extension to generalized definitions of collateral. What is hidden behind OIS discounting (and when it cannot be used)?
- Assets (bonds) collateral. Not all CSA/collateral agreements are based on cash. Generalization of collateral results for collateral with assets (collateral square)
- Foreign currency collateral. Impact of foreign currency cash collateral on valuation
Multi-curve framework
- Definitions and fundamental hypothesis of the framework. The relation to collateral. The basic instruments. The multi-curve framework is based on relatively simple hypothesis, but those hypotheses are far reaching with subtle impacts
- Curve description: Defining flexible curves. Spread curves. What to interpolate? Impact of interpolation on risk
- Curve calibration:
- Standard curves or simultaneous calibration. The multi-curve framework is more than a juxtaposition of single curves. The curves interact and calibrating them simultaneously is often required. The basis swaps have also an impact on how to look at risk. Several markets have idiosyncrasies that need to be taken into account: two-swaps basis, swaps in EUR, Fed Funds swaps in USD, change of frequency for AUD IRS
- Curves are never simple. Incorporating turn-of-year, central bank meeting dates, and dealing with sparse data
- Risk computation: the growing number of (delta) risk figures. With multiple curves, the number of risk factors is also multiplied. How to look at risks for (linear) products
- Jacobian/transition matrices
- The market quotes are quite heterogeneous in term of instrument used and tenors. Standardization of nodes and remapping of risk make it easier to read reports. It can also be used to store/use historical data for VaR, scenarios, and statistical analysis
- Risk management in a multi-curve/multi-currency framework
Benchmarks
- Changes in benchmarks. Changes are expected for the main benchmarks – like LIBOR – under regulatory pressure, with new overnight benchmarks predicted to replace them
Workshop: Curve calibration
- Curve calibration
- Risk management
- Foreign currency collateral
- How appearance of risk is changing with the selection of calibration instruments
All curve calibration and collateral examples use production grade open source code (the code is used by banks, CCPs, hedge funds). As the code is open source (Apache 2 license), participants will be able to take away the examples and run them using their own data without limitation.
Day Two
Interest rate modeling
- Modeling with collateral. Dynamic term structure models have been developed to cover collateral discounting. Even if they are partly similar to the single-curve interest rate models, the collateral adds an extra layer of complexity and an extra layer of spreads to deal with. A large part of the financial mathematics and numerical analysis developed in the single-curve framework can be reused, but some additional issues have to be taken into account
- Modeling vanilla instruments: IRS, OIS, FRA, basis swaps, STIR futures, swaptions, cap/floor, etc.
- Review of different multi-curve dynamic models proposed in the literature: deterministic spread, full-term structure models, parsimonious model, rational model, additive and multiplicative spreads, and hybrid models
- Models for multi-currency collateral
- Collateral optionality
Benchmarks
- Fall-back clauses are proposed in case of discontinuation of exiting benchmarks. What are those proposals? What is the impact of the proposals on the valuation of existing portfolios? Analysis of vanilla products applying the models developed in the first part of the program
- New products associated to new benchmarks, e.g. futures on overnight benchmarks, deliverable swap futures
Workshop: Multi-curve stochastic models
- Impact of the choice of stochastic model on the price of vanilla instruments
- Example of futures and FRA convexity adjustments
- Impact of fall-back clauses in case of LIBOR discontinuation
All stochastic model examples also use production grade open source code.
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