Spread ladder swaps - an analysis of controversial interest rate derivatives

Professorship/Faculty: Banking and Financial Control  
Author(s): Muck, Matthias
Title of the Journal: Financial Markets and Portfolio Management
ISSN: 1555-4961
Corporate Body: Swiss Society for Financial Market Research
Publisher Information: Heidelberg [u.a.] : Springer
Year of publication: 2012
Volume: 26
Issue: 2
Pages: 269-289
Illustrations: Diagramme
Year of first publication: 2012
Language(s): English
DOI: 10.1007/s11408-012-0186-1
URL: http://www.springerlink.com/content/mq05243u4j0...
This article analyzes spread ladder swaps traded by Deutsche Bank to several medium-size companies and municipalities. The value of these contracts is highly sensitive to correlations between forward rates. For a contract that was challenged by the medium-size company Ille at the Federal Court of Germany, it turns out that the derivative was originated at a negative market value of −90,000 to −115,000 euros (depending on the number of factors used in the model). Moreover, the model correctly predicts the range for the terminal payment after an adverse development of the term structure of approximately 567,000 euros. We also investigate a product feature that limits the upside potential from the viewpoint of the customer and show that it has a substantial impact on market values. According to the judgment handed down by the court, the bank should have informed the customer about the market value of the product in light of special circumstances. This raises questions as to which products must meet this requirement. Moreover, especially for exotic contracts, market prices are mostly model prices: for spread ladder swaps, substantially different prices are obtained even when investors agree on the variance/covariance matrix but disagree on the number of factors to apply in an implementation of a model.
Keywords: Spread ladder swaps, Derivatives, LIBOR market model
Peer Reviewed: Ja
International Distribution: Ja
Document Type: Article
URI: https://fis.uni-bamberg.de/handle/uniba/476
Year of publication: 13. November 2012