Model risk in the transition to risk-free rates

Transition is an opportunity to reduce multi-rate complexities, say Bakkar and Brigo

The transition from interbank offered rates (Ibors) to new risk-free rates (RFRs) has been heavily debated by policymakers, regulators and market participants over the past few years. It will be a massive undertaking, affecting hundreds of trillions of dollars’ worth of contracts. This will have to be managed carefully to avoid great disruption – not least from a modelling perspective.

Since the financial crisis, derivatives valuation has moved a long way towards incorporating multiple curves