Marco, Bianchetti (2011): The Zeeman Effect in Finance: Libor Spectroscopy and Basis Risk Management.
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Once upon a time there was a classical financial world in which all the Libors were equal. Standard textbooks taught that simple relations held, such that, for example, a 6 months Libor Deposit was replicable with a 3 months Libor Deposits plus a 3x6 months Forward Rate Agreement (FRA), and that Libor was a good proxy of the risk free rate required as basic building block of no-arbitrage pricing theory. Nowadays, in the modern financial world after the credit crunch, some Libors are more equal than others, depending on their rate tenor, and classical formulas are history. Banks are not anymore “too big to fail”, Libors are fixed by panels of risky banks, and they are risky rates themselves. These simple empirical facts carry very important consequences in derivative’s trading and risk management, such as, for example, basis risk, collateralization and regulatory pressure in favour of Central Counterparties. Something that should be carefully considered by anyone managing even a single plain vanilla Swap. In this qualitative note we review the problem trying to shed some light on this modern animal farm, recurring to an analogy with quantum physics, the Zeeman effect.
|Item Type:||MPRA Paper|
|Original Title:||The Zeeman Effect in Finance: Libor Spectroscopy and Basis Risk Management|
|Keywords:||crisis; liquidity; credit; counterparty; risk; fixed income; Libor; Euribor; Eonia; yield curve; forward curve; discount curve; single curve; multiple curve; collateral; CSA-discounting; liquidity; funding; no arbitrage; pricing; interest rate derivatives; Deposit; FRA; Swap; OIS; Basis Swap; Zeeman; Lorentz; quantum mechanics; atomic physics|
|Subjects:||E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E43 - Interest Rates: Determination, Term Structure, and Effects
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing; Futures Pricing
|Depositing User:||Marco Bianchetti|
|Date Deposited:||28. Oct 2012 03:50|
|Last Modified:||15. Feb 2013 08:16|
 See Zeeman’s biography at the Nobel Prize website http://nobelprize.org and Wikipedia at http://en.wikipedia.org/wiki/Pieter_Zeeman.
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