The Irony in the Derivatives Discounting
10 Pages Posted: 14 Mar 2007
Date Written: March 2007
A simple and fundamental question in derivatives pricing is the way (contingent) cash-flows should be discounted. As cash can not be invested at Libor the curve is probably not the right discounting curve, even for Libor derivatives. The impact on derivative pricing of changing the discounting curve is discussed. The pricing formulas for vanilla products are revisited in the funding framework described.
Keywords: Cost of funding, coherent pricing, interest rate derivative pricing, Libor, irony.
JEL Classification: G13, E43, C63
Suggested Citation: Suggested Citation