Fixed-Income Pricing in a Non-Linear Interest-Rate Model

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This paper introduces a novel kind of interest-rate model offering simple analytical pricing formulas for swaps, futures, swaptions, caps and floors. The model is based on an original use of regime-switching features that makes it consistent with the non-linear behavior of interest rates. In particular, it accommodates the fact that short-term rate fluctuations are mainly driven by discrete changes in the central-bank policy rates. An application on euro-area data shows how the model can be exploited to infer risk-neutral probabilities of central-bank rate decisions.

Fixed-Income Pricing in a Non-Linear Interest-Rate Model

Renne

2014

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Options Embedded in ECB Targeted Refinancing Operations

Renne

2014

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In June 2014, the European Central Bank (ECB) announced the implementation of new refinancing operations aimed at supporting bank lending to the non-financial private sector. This paper exhibits and prices options embedded in these Targeted Longer-Term Refinancing Operations. In particular, it shows how these options participate to the incentive mechanisms at play in these operations. Quantitative results point to substantial gains -for participating banks-attached to the satisfaction of lending conditions defined by the scheme.

Pre-Crisis Credit Standards: Monetary Policy or the Savings Glut?

Penalver

2014

This paper presents a theoretical model of bank credit standards. It examines how a monopoly bank sets its monitoring intensity in order to manage credit risk when it makes long duration loans to borrowers who have private knowledge of their project's stochastic profitability. The model has a recursive structure and contains heterogeneous agents who can selfselect to be depositors or borrowers at any point in time. The bank loan contract considered specifies the interest rate, the monitoring intensity and a profitability covenant. Within this class of contract, he bank chooses the terms which maximise Markov stationary profits subject to the constraint that it must have as many deposits as loans. As an illustrative example, the model is used to consider whether the reduction in credit standards and credit spreads observed before the financial crisis could have been caused by low official interest rates or a positive deposit shock. The model rejects a risk-taking channel of monetary policy and endorses the savings glut hypothesis.