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Discounting, LIBOR, CVA and Funding: Interest Rate and Credit Pricing (Applied Quantitative Finance)
 
 

Discounting, LIBOR, CVA and Funding: Interest Rate and Credit Pricing (Applied Quantitative Finance) [Kindle Edition]

Dr Chris Kenyon , Dr Roland Stamm
3.0 out of 5 stars  See all reviews (1 customer review)

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Review

'The ongoing economic situation is pushing researchers to re-discuss and update the fundamentals of financial modeling. Writing an encyclopaedic book on financial modeling for exotics based on the risk free rate, a unique discount curve, no credit risk and no liquidity costs would be neither relevant nor realistic in 2012. This is not such a book. The reader will find here an interesting tackling of current and relevant problems such as multi-curve modeling and credit valuation adjustments, with a very interesting discussion of closeout and especially goodwill, which cannot be found anywhere else to the best of this endorser's knowledge. Funding costs, hints at systemic risk, regulation and Basel III are also considered. It is great to find a quantitatively detailed analysis of such aspects in a single book, and readers who are open-minded and attentive to the current challenges posed by the market will find this book to be informative, relevant, pleasant to read and even entertaining.' - Professor Damiano Brigo, Head of the Mathematical Finance Research Group, Imperial College, London, UK, and author of Interest Rate Models: Theory and Practice and Credit Models and the Crisis.

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The credit and sovereign debt crises have fundamentally changed the way participants in the global financial markets perceive credit risk. In market practice this is most directly visible from significant bases throughout the interest rate world, especially tenor bases, cross-currency bases, and bond-CDS bases. This means that the curve used for discounting is no longer the curve used for LIBOR (aka Fixing Curve or Forwarding Curve). In the last two years a consensus has emerged that this multi-curve pricing is now standard.

The crises have also altered the perception of banks and governments - they are no longer regarded as zero-risk counterparties. Now both sides of an uncollateralized trade need to consider, and price in, the risk that the other defaults: my CVA is your DVA. Even collateralization does not remove pricing problems: when you post collateral how much do you have to pay for it? This FVA is not symmetric in many ways: whatever it costs you to source it, your counterparty will only pay you OIS. Even worse is that your funding costs are unlikely to be the same as those of all your counterparties.

Discounting, LIBOR, CVA and Funding: Interest Rate and Credit Pricing is the first book to illustrate new ways of pricing interest rate and credit products in the post-crisis markets. Written by two seasoned practitioners, it will enable the readers to understand the many different versions of credit and basis spreads, and to build the appropriate discount curves that take these spreads into account so that collateralized derivatives will be priced correctly. The authors guide the reader through the complexity added by OIS discounting and multi-curve pricing as well as CVA, DVA and FVA.
 
Derivatives do not exist in a vacuum. Regulators worldwide have reacted strongly to the crises with the introduction of Basel III. Hitherto quants could ignore capital costs and charges, but as of January 2013 this world is gone. Discounting, LIBOR, CVA and Funding explains details of Basel III that are important for pricing, especially around the CVA VaR and default exposure capital charges.

This book will be required reading for quantitative practitioners who need to keep up-to-date with the latest developments in derivatives pricing, and will also be of interest to academic researchers and students interested in how instruments are priced in practice.

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7 of 8 people found the following review helpful
By Dragon
Format:Hardcover|Verified Purchase
The subject of the book (Discounting, CVA, Funding) is timely given the changes in quantitative finance over the last 5 years. The short book introduces the different subjects. For a short book it tries to cover too many subjects.

I bought the book mainly for the discounting part (the so-called OIS discounting or multi-curves framework). The book describes some of its features. To my opinion it fails to do justice to the subject. The original literature where it was proposed is referenced only sparsely; there is a lack of clear definition of some of the fundamental concepts used; the curve construction described is a very simplified version of what is used in practice. The book is enough for a quick informal overview but not to use it in research or in practical implementation.

In conclusion, I don't strongly regret buying this book, but I will need to buy other books on each of the subjects (multi-curves, CVA and funding) to have a better understanding of the subject.
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