The basis goes stochastic
The one-curve world of pre-crisis modelling is long gone – now derivatives desks need to use a variety of fixings depending on the product traded. Here, Fabio Mercurio and Zhenqiu Xie show how a stochastic multi-curve world can be modelled excluding arbitrage
Since August 2007, the basis between Libor and the overnight index swap (OIS) rate has expanded and become stochastic. Single interest rate curve modelling has become obsolete, and multi-curve models have been introduced to price interest rate derivatives (see, for example, Whittall, 2010). The market has settled on new valuation formulas for vanilla instruments, with natural modifications of the classic single-curve ones. But the pricing of non-vanilla options still has unsolved challenges, and
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