INTERBANK CREDIT RISK MODELING WITH SELF-EXCITING JUMP PROCESSES

Charles Guy Njike Leunga and Donatien Hainaut ()
Additional contact information
Charles Guy Njike Leunga: Institute of Statistics, Biostatistics and Actuarial Sciences (ISBA), Université Catholique de Louvain, Voie du Roman Pays 20, 1348 Louvain-la-Neuve, Belgium
Donatien Hainaut: Institute of Statistics, Biostatistics and Actuarial Sciences (ISBA), Université Catholique de Louvain, Voie du Roman Pays 20, 1348 Louvain-la-Neuve, Belgium

International Journal of Theoretical and Applied Finance (IJTAF), 2020, vol. 23, issue 06, 1-32

Abstract: The credit crunch of 2007 caused major changes in the market of interbank rates making the existing interest rate theory inconsistent. This paper puts forward one way to reconcile practice and theory by modifying the arbitrage-free condition. In this framework, the forward Libor rate is no longer considered as a risk-free rate and the credit and liquidity risks within the interbank market partly drive its dynamics. In a similar manner to the multiple-curve approach, we model the evolution of default-free rates, assimilated to overnight interest swap rates, and the default times of an interbank market segment determined by its tenor. For each segment, we use the reduced form approach to model the arrival rate of defaults with a self-exciting jump-diffusion process. Then, we deduce the dynamics of the spot forward Libor rates and provide closed-form approximation pricing formulae for options on forward Libor rates and swap rates. Even in a context of negative interest rates and compared to other forms of intensity processes such as a CIR, the self-excitation property allows a better understanding of the spread OIS-IRS and provides information about the interbank credit risk. Furthermore, our framework enables to parse the impact of the interbank credit risk on forward Libor as well as on interest rates derivatives like caps, floors, and swaptions.

Keywords: Interest rates; multiple curves; self-exciting process; simple forward Libor rate (search for similar items in EconPapers)
Date: 2020
References: Add references at CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://www.worldscientific.com/doi/abs/10.1142/S0219024920500399
Access to full text is restricted to subscribers

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wsi:ijtafx:v:23:y:2020:i:06:n:s0219024920500399

Ordering information: This journal article can be ordered from

DOI: 10.1142/S0219024920500399

Access Statistics for this article

International Journal of Theoretical and Applied Finance (IJTAF) is currently edited by L P Hughston

More articles in International Journal of Theoretical and Applied Finance (IJTAF) from World Scientific Publishing Co. Pte. Ltd.
Bibliographic data for series maintained by Tai Tone Lim ().