Small banks face rate options valuation model change

Negative rates seen in a number of jurisdictions are causing the Black model to break down when valuing embedded interest rate options. Smaller banks had hoped the storm would blow over, but are now facing an overhaul of their valuation models

Negative interest rates have forced many traders to think differently. Normally, a party lending to another is compensated for its opportunity cost and the credit risk it is taking. However, with quantitative easing pushing interest rates close to zero or even into the negative in the eurozone, banks have had to consider some of the stranger effects it can cause on their valuation models.

It is a particular challenge for structured products with embedded interest rate options, as the most widely