Curve Building and SwapPricing in the Presence of Collateral and Basis Spreads
The eruption of the financial crisis in 2008 caused immense widening of both domestic and cross currency basis spreads. Also, as a majority of all fixed income contracts are now collateralized the funding cost of a financial institution may deviate substantially from the domestic Libor. In this thesis, a framework for pricing of collateralized interest rate derivatives that accounts for the existence of non-negligible basis spreads is implemented. It is found that losses corresponding to several percent of the outstanding notional may arise as a consequence of not adapting to the new market conditions.
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