Consistent Valuation Across Curves Using Pricing Kernels
AbstractThe 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. View Full-Text
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Macrina, A.; Mahomed, O. Consistent Valuation Across Curves Using Pricing Kernels. Risks 2018, 6, 18.
Macrina A, Mahomed O. Consistent Valuation Across Curves Using Pricing Kernels. Risks. 2018; 6(1):18.Chicago/Turabian Style
Macrina, Andrea; Mahomed, Obeid. 2018. "Consistent Valuation Across Curves Using Pricing Kernels." Risks 6, no. 1: 18.