Using futures in yield curve calibration

Using futures in yield curve calibration

Lee, Alexander (TU Delft Electrical Engineering, Mathematics and Computer Science)

Oosterlee, Kees (mentor)
Iskra, Marko (mentor)
Grzelak, Lech (mentor)
Fokkink, Robbert (mentor)

Delft University of Technology

2019-09-16

The yield curve represents market supply and demand implied expectations of future interest rates and is calibrated from the most liquidly traded interest rate derivatives like cash deposits, forward rate agreeents, swaps and futures. Due to the daily margining mechanism of futures contracts, interest rate futures require the substraction of a convexity adjustment in order for them to be used in curve calibration. It is common practice to use externally computed convexity adjustments, which treats the convexity adjustment as a black-box parameter. We will argue the inherent relationship between the convexity adjustment and cap/floor volatility smiles and derive a nested calibration algorithm for the simultaneous calibration of the yield curve to futures and the convexity adjustment to cap/floor volatility surfaces. This introduces dependencies of the yield curve to option volatilities and we will argue that for simple interest rate derivatives the implied vegas are negligible. .

Futures
Interest rates
Calibration
Greeks
Volatility smile
Yield curve

http://resolver.tudelft.nl/uuid:27b216aa-a514-4339-a6e2-80952d19d794

Student theses

master thesis

© 2019 Alexander Lee