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The financial industry has undergone a significant transition from the London Interbank Offered Rates (LIBORs) to Risk Free Rates (RFRs) such as, e.g., the Secured Overnight Financing Rate (SOFR) in the U.S. and the Cash Rate (AONIA) in Australia, as primary benchmark rates for borrowing costs. The paper examines the pricing and hedging method for financial products in a cross-currency framework with the special emph…
In the third part of this series we introduce consistent relative value measures for CDS-Bond basis trades using the bond-implied CDS term structure derived from fitted survival rate curves. We explain why this measure is better than the traditionally used Z-spread or Libor OAS and offer simplified hedging and trading strategies which take advantage of the relative value across the entire range of maturities of cash …
The cross-currency basis, which is the basis spread added mainly to the U.S. dollar London Interbank Offered Rate (USD LIBOR) when the USD is funded via foreign exchange (FX) swaps using the Japanese yen or the euro as a funding currency, has been widening globally since the beginning of 2014. This development is driven by (1) increased demands for U.S. dollars resulting from a divergence in the monetary policy betwe…
Over the last decade, the foreign exchange derivatives market has witnessed a collapse of covered interest parity (CIP). Not only does this collapse give rise to large deviations from CIP, it has unlocked a stream of exploitable arbitrage opportunities across currencies. In this paper, we introduce two new factors – inflation differential and relative economic performance – as potential drivers of deviations from CIP…
We study permissionless spot--perpetual basis trading in decentralized finance as a collateral control problem. The strategy holds spot inventory, hedges directional exposure with a short perpetual, and allocates capital between spot inventory and derivative margin under on-chain liquidity and execution frictions. The paper delivers three results. First, it solves a static control problem for the collateral share and…
Weather parametric insurance relies on weather indices rather than actual loss assessments, enhancing claims efficiency, reducing moral hazard, and improving fairness. In the context of increasing climate change risks, despite growing interest and demand,, weather parametric insurance's market share remains limited due to inherent basis risk, which is the mismatch between actual loss and payout, leading to loss witho…
We provide a general HJM framework for forward contracts written on abstract market indices with arbitrary fixing and payment adjustments, and featuring collateralization in any currency denominations. In view of this, we first provide a thorough study of cross-currency markets in the presence of collateral and incompleteness. Then we give a general treatment of collateral dislocations by describing the instantaneous…
Collateralization with daily margining has become a new standard in the post-crisis market. Although there appeared vast literature on a so-called multi-curve framework, a complete picture of a multi-currency setup with cross-currency basis can be rarely found since our initial attempts. This work gives its extension regarding a general framework of interest rates in a fully collateralized market. It gives a new form…
Covered interest parity verges on a physical law in international finance. And yet it has been systematically violated since the Great Financial Crisis. Especially puzzling have been the violations since 2014, even once banks had strengthened their balance sheets and regained easy access to funding. We offer a framework to think about these violations, stressing the combination of hedging demand and tighter limits to…
This paper introduces a novel stochastic model for credit spreads. The stochastic approach leverages the diffusion of default intensities via a CIR++ model and is formulated within a risk-neutral probability space. Our research primarily addresses two gaps in the literature. The first is the lack of credit spread models founded on a stochastic basis that enables continuous modeling, as many existing models rely on fa…
Data analysis with log-periodical parametrization of the Brent oil price dynamics has allowed to estimate (very approximately) the date when the dashing collapse of the Brent oil price will achieve the absolute minimum level (corresponding to the so-called singularity point), after which there will occur a rather rapid rebound, whereas the accelerating fall of the oil prices which started in mid-2014 will come to an …
We develop a variational formulation of Kyle's model of informed trading that accommodates stochastic liquidity and multiple traded assets. The main equilibrium result is stated first: under a martingale dual condition, a matrix-valued martingale depth process generates a linear-Gaussian equilibrium with stochastic matrix-valued price impact. We derive this martingale from a primal-dual problem, inspired by causal op…
Explicitly taking into account the risk incurred when borrowing at a shorter tenor versus lending at a longer tenor ("roll-over risk"), we construct a stochastic model framework for the term structure of interest rates in which a frequency basis (i.e. a spread applied to one leg of a swap to exchange one floating interest rate for another of a different tenor in the same currency) arises endogenously. This rollover r…
Recently, incomplete-market techniques have been used to develop a model applicable to credit default swaps (CDSs) with results obtained that are quite different from those obtained using the market-standard model. This article makes use of the new incomplete-market model to further study CDS hedging and extends the model so that it is capable treating single-name CDS portfolios. Also, a hedge called the vanilla hedg…
We give a comprehensive review of credit term structure modeling methodologies. The conventional approach to modeling credit term structure is summarized and shown to be equivalent to a particular type of the reduced form credit risk model, the fractional recovery of market value approach. We argue that the corporate practice and market observations do not support this approach. The more appropriate assumption is the…
In this three-part series of papers, we argue that the conventional spread measures are not well defined for credit-risky bonds and introduce a set of credit term structures which correct for the biases associated with the strippable cash flow valuation assumption. We demonstrate that the resulting estimates are significantly more robust and remain meaningful even when applied to deeply distressed bonds. We also sugg…
This paper develops a three-currency Heath-Jarrow-Morton framework in which corporate credit is treated as a separate economy, connected to the nominal and real economies through synthetic inflation and credit exchange rates. The framework produces a testable identity. Under joint no-arbitrage, the credit spread of an issuer expressed over the inflation-rateindexed risk-free curve equals the same issuer's credit spre…
In the LIBOR era, banks routinely tied revolving credit facilities to credit-sensitive benchmarks. This study assesses the Across-the-Curve Credit Spread Index (AXI) -- a transparent, transaction-based measure of wholesale bank funding costs -- as a complement to SOFR, summarizing its behavior, construction, and loan-pricing implications. AXI aggregates observable unsecured funding transactions across short- and long…
Cheap and rich are relative-value words: cheap means wide or low versus a model, a history, or a hedge; rich means tight or expensive on that same yardstick — not ‘I like the story.’
CS01 is the dollar value of one basis point of credit spread — how much the book makes or loses if the name or index OAS/CDS widens by 1 bp.
DV01 is the dollar value of one basis point: how much the position’s mark changes if the yield (or the curve point you risk on) moves by 0.01%.
CDS Basis Trade — Arbitrage between cash bonds and CDS contracts revealing funding and counterparty frictions.
Cheapest-to-deliver is the bond a futures (or CDS) seller will deliver because it minimizes their cost — the option that sits inside the contract.
Capital Controls — Official restrictions on cross-border flows that reprice FX basis and investability.
USD/JPY cross-currency basis measures the extra cost of obtaining dollars through FX swap markets and is a key indicator of offshore dollar funding stress.
Funding stress signal derived from FX swap pricing distortions and balance sheet constraints.
Capital Controls — Official restrictions on cross-border flows that reprice FX basis and investability.
CDS Basis Trade — Arbitrage between cash bonds and CDS contracts revealing funding and counterparty frictions.
Funding stress signal derived from FX swap pricing distortions and balance sheet constraints.
CS01 is the dollar value of one basis point of credit spread — how much the book makes or loses if the name or index OAS/CDS widens by 1 bp.
DV01 is the dollar value of one basis point: how much the position’s mark changes if the yield (or the curve point you risk on) moves by 0.01%.
USD/JPY cross-currency basis measures the extra cost of obtaining dollars through FX swap markets and is a key indicator of offshore dollar funding stress.