White Paper - The USD Cleared Swap Curve

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Gary Goldberg, Principal Financial Engineer at Calypso Technology, recommends a methodology for building USD interest rate curves to price cleared swaps

This article presents Calypso’s recommendations for building USD interest rate curves for the pricing of cleared swaps. We begin with a review of, (a) the need for two curves (the discount curve reflecting the collateral funding rate and the index curve forecasting the rate index) and, (b) the instruments that will be used for building the curves given current market conditions, emphasizing the need for those with the greatest liquidity. Noting that a curve is not completely specified by the instruments alone, we describe the desirability of specifying curves further by choosing certain shapes and relationships. We emphasize the importance of modeling the overnight rates in a way that reflects market expectations and avoids spurious oscillations. The importance of Federal Reserve actions in dominating the short end of both curves is described. The importance of the FRA-OIS spread in governing the relation between the discount and index curves is illustrated with a detailed example. The recommendations in this article are believed to produce curves that are a reflection of market economics, easy to build, and do not allow arbitrage.

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