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I have a Dynamic Nelson Siegel (DNS) based rv model.

I want to know if I can use pre and post-crises curves interchangeably in my calibration and out of sample testing. I.e. those without OIS discounting pre-crises and those with OIS discounting that we observe today?

I had hoped that even though they are derived differently the market rates themselves will not have changed in terms of their relative value (if 2-10 looks flat then it still looks flat post crises) same for butterfly trades (and their dynamics should also be unchanged). The differences are in the PnL of the host institutions who can no longer fund at Libor but for my purposes i.e. relative value (I am hoping) it is not necessary to introduce this complication am I right. I can just calculate the PnL in terms of the basis point changes observed (I effectively assume that I am an institution that can fund at Libor throughout)? Or is it like comparing apples and oranges?

Baz

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For RV purposes, I have actually continued to use libor discounting for simplicity; otherwise, you'd have to model multiple curves, which become very difficult to work with...

That being said, the curve has been trading very differently after the crises. For example, 5y typically didn't deviate that much from 2y and 10y on relative value basis historically, but after the crisis, 5s traded RIDICULOUSLY rich relative to 2s and 10s ALWAYS (until recently). Doesn't mean your model doesn't work any more, but it does make interpreting model output a bit more challenging.

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  • $\begingroup$ Thanks for this I realize things have changed post crises but this is not due to the move to OIS discounting would you agree? $\endgroup$ – Bazman Jun 23 '14 at 15:24
  • $\begingroup$ Correct, sectors that richened a lot are those that the Fed bought a lot of securities in. $\endgroup$ – Helin Jun 23 '14 at 16:03
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The RV analysis of discounting at Libor will differ to that at OIS. It is like comparing apples to oranges.

The main driver for this would be a term structure to the basis, but Libor RV is surely only a strategy when holding the Libor-bond package?

An ideal cash strategy would use both, or calibrate according to the investment behaviours of peers.

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