Options, Futures, and Other Derivatives, Ninth Edition

Chapter 9 OIS Discounting, Credit Issues, and Funding Costs

This chapter discusses a number of issues that have become important in derivatives markets since the credit crisis of 2007. The first of these concerns the choice of a risk-free discount rate. This is important because, as we will see in later chapters, the valuation of almost any derivative involves discounting expected cash flows at a risk-free rate. Prior to the credit crisis, market participants usually used LIBOR/swap rates as proxies for risk-free rates. They constructed a zero curve from LIBOR rates and LIBOR-for-fixed swap rates as described in Section 7.6 and used this to provide risk-free zero rates. Since the crisis, they have started to use other proxies in some circumstances. ...