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The physical cash presence in the final transactions is one of the issues in the presently observed negative interest rates bonds. Such a situation has historically been modelled within the "liquidity trap" theory, forecasting the introducing of a unique plasma currency in order to solve inflational problems. But currently one is observing both electronic-trading /credit cards/checks based- (software-) and physical money flows, with country-specific interchange rates.

In the present netting system an additional netting is therefore showing up: the one of software cash flows. From the perspective of limited monetary mass, all the pricing instruments should have different formulae for the software and non-software settlement. The evolution of interest rates allowing for negative values need to be portfolio-specific and modeled taking into account not only the time, but also the frequency and the magnitude of the overall non-software flows.

Would, in your opinion, dedicated pricing and modelling of the two different forms of cash flows make a difference?

I thought of seeing this extra netting in place, from the portfolio's owner point of view, by having the physical flows considered as observed values. The negatives (outgoing principals) will be discounted at the effective funding rate (the by-principal-weighted average of all the incoming/positive non-software flows) and the positives (deposited) should be discounted at the average opportunity of investing rate (the weighted-by-principal return rate of all the non-software future flows). The treasury's rates (where they exist) might be taken as a proxy for effective funding and opportunity of investing rates when calculating present value of non-software cash flows. This might be treated as a technical detail of what to do if differentiating the two, so not necessarily within this topic.

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  • $\begingroup$ No. The shadow pricing of goods theory can explain the presently observed negative interest rates bonds. A shadow interest rate shows when the expected return is greater than interest rate (as firms wish to borrow more at given interest rate than they can) and opportunity cost of funds is greater than interest rate. Considering two additional nettings (over the software and physical currencies) at the level of the modelled portfolio, the treasury department does the asset versus liability management. Frequency, magnitude, settlement methods do get involved in such a modelling. $\endgroup$
    – user7056
    Aug 28, 2012 at 17:34

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No. The shadow pricing of goods theory can explain the presently observed negative interest rates bonds. A shadow interest rate shows when the expected return is greater than interest rate (as firms wish to borrow more at given interest rate than they can) and opportunity cost of funds is greater than interest rate.

Considering two additional ulimate local nettings (over the software- and physical-money) at the level of the modelled portfolio, the treasury department does the asset versus liability management. Frequency, magnitude, settlement methods do get involved in such a modelling.

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