FX Modelling in Collateralized Markets: Foreign Measures, Basis Curves, and Pricing Formulae

33 Pages Posted: 19 Aug 2015 Last revised: 17 Sep 2015

See all articles by Nicola Moreni

Nicola Moreni

Intesa Sanpaolo, CIB Division, Global Markets

Andrea Pallavicini

Intesa Sanpaolo

Date Written: September 14, 2015

Abstract

We present a general derivation of the arbitrage-free pricing framework for multiple-currency collateralized products. We include the impact on option pricing of the policy adopted to fund in foreing currency, so that we are able to price contracts with cash flows and/or collateral accounts expressed in foreign currencies inclusive of funding costs originating from dislocations in the FX market. Then, we apply these results to price cross-currency swaps under different market situations, to understand how to implement a feasible curve bootstrap procedure. We present the main practical problems arising from the way the market is quoting liquid instruments: uncertainties about collateral currencies and renotioning features. We discuss the theoretical requirements to implement curve bootstrapping and the approximations usually taken to practically implement the procedure. We also provide numerical examples based on real market data.

Keywords: Arbitrage-Free Pricing, Collateral, Collateral Convexity, Funding Costs, Funding Policy, Foreign Currency, FX Market, FX Swap, Cross-Currency Swap, Curve Boot- strapping, Multiple Currencies, Currency Triplets

JEL Classification: G13

Suggested Citation

Moreni, Nicola and Pallavicini, Andrea, FX Modelling in Collateralized Markets: Foreign Measures, Basis Curves, and Pricing Formulae (September 14, 2015). Available at SSRN: https://ssrn.com/abstract=2646516 or http://dx.doi.org/10.2139/ssrn.2646516

Nicola Moreni (Contact Author)

Intesa Sanpaolo, CIB Division, Global Markets

Largo R.Mattioli 3
P.O. BOX 8319
Milan, Milan 20121
Italy

Andrea Pallavicini

Intesa Sanpaolo ( email )

Largo Mattioli 3
Milan, MI 20121
Italy

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
499
Abstract Views
1,612
Rank
104,268
PlumX Metrics