Macrina, A;
Mahomed, O;
(2018)
Consistent valuation across curves using pricing kernels.
Risks
, 6
(1)
10.3390/risks6010018.
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Abstract
Licensee MDPI, Basel, Switzerland. The general problem of asset pricing when the discount rate differs from the rate at which an asset’s cash flows accrue is considered. A pricing kernel framework is used to model an economy that is segmented into distinct markets, each identified by a yield curve having its own market, credit and liquidity risk characteristics. The proposed framework precludes arbitrage within each market, while the definition of a curve-conversion factor process links all markets in a consistent arbitrage-free manner. A pricing formula is then derived, referred to as the across-curve pricing formula, which enables consistent valuation and hedging of financial instruments across curves (and markets). As a natural application, a consistent multi-curve framework is formulated for emerging and developed inter-bank swap markets, which highlights an important dual feature of the curve-conversion factor process. Given this multi-curve framework, existing multi-curve approaches based on HJM and rational pricing kernel models are recovered, reviewed and generalised and single-curve models extended. In another application, inflation-linked, currency-based and fixed-income hybrid securities are shown to be consistently valued using the across-curve valuation method.
| Type: | Article |
|---|---|
| Title: | Consistent valuation across curves using pricing kernels |
| Open access status: | An open access version is available from UCL Discovery |
| DOI: | 10.3390/risks6010018 |
| Publisher version: | https://doi.org/10.3390/risks6010018 |
| Language: | English |
| Additional information: | Copyright © 2018 by the authors. Licensee MDPI, Basel, Switzerland. This article is an open access article distributed under the terms and conditions of the Creative Commons Attribution (CC BY) license (http://creativecommons.org/licenses/by/4.0/). |
| Keywords: | pricing kernel approach; rational pricing models; multi-curve term structures; OIS and LIBOR; spread models; HJM; multi-curve potential model; linear-rational term structure models; inflation-linked and foreign-exchanged securities; valuation in emerging markets |
| UCL classification: | UCL UCL > Provost and Vice Provost Offices UCL > Provost and Vice Provost Offices > UCL BEAMS UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Maths and Physical Sciences UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Maths and Physical Sciences > Dept of Mathematics |
| URI: | https://discovery.ucl.ac.uk/id/eprint/10044827 |
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