Séminaire 'Un chercheur du GERAD vous parle!'

Titre : On the jump risk in American-Style interest-rate derivatives and central clearing of credit default swaps

Conférencier : Mohamed Ali Akari – HEC Montréal, Canada

In this work, we investigate the impact of the presence of jumps in affine interest-rate models on the pricing of options embedded in American-style interest-rate derivatives. To do so, we first propose a general pricing framework relying on dynamic programming combined with the transform analysis for affine jump diffusion processes proposed in Duffie, Pan & Singleton (2000). We then examine the effect of the jump premium on the prices of implicit options. We provide empirical results when the proposed method is applied to the pricing of risk-free bonds with embedded options, Bermudan swaptions, and U.S. T-Bond futures. The analysis is conducted under the Vasicek model (1977) augmented with exponential jumps estimated when the term structure of interest rates is calibrated to the one actually observed.

We also examine the impact of the voluntary central clearing scheme on the credit default swap (CDS) market. We use data on North American firms during the period 2009-2015. By combining propensity score matching and generalized difference-in-differences, our methodology addresses the endogeneity problem arising from the fact that central clearing is not mandatory for CDS single names. We find that CDS spreads increase with the initiation of central clearing and we do not find any evidence of an improvement in liquidity or trading activity. We argue that this surge in CDS spreads is due to the elimination of counterparty risk and that the magnitude of this increase represents an evaluation of this risk.

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