Paper: arXiv 2410.08477

Authors: Yining Ding, Ruyi Liu, Marek Rutkowski

Abstract

The financial industry has undergone a significant transition from the London Interbank Offered Rates (LIBORs) to Risk Free Rates (RFRs) such as, e.g., the Secured Overnight Financing Rate (SOFR) in the U.S. and the Cash Rate (AONIA) in Australia, as primary benchmark rates for borrowing costs. The paper examines the pricing and hedging method for financial products in a cross-currency framework with the special emphasis on the Compound SOFR vs Average AONIA cross-currency basis swap (CCBS) where both reference rates are backward-looking and the swap is collateralized. While the SOFR and AONIA are used as particular instances of RFRs in a cross-currency basis swap, the proposed approach is able to handle backward-looking rates for any two currencies. We give explicit pricing and hedging results for a constant notional cross-currency basis swap with either domestic or foreign collateralization using interest rate futures and currency futures as hedging instruments within an arbitrage-free cross-currency multi-curve setting.

Complexity vs Empirical Score

  • Math Complexity: 8.5/10
  • Empirical Rigor: 3.5/10
  • Quadrant: Lab Rats — theoretically deep, empirically untested

Why this score: The paper presents a highly rigorous mathematical framework using multi-curve term structure models to derive explicit pricing and hedging formulas for cross-currency basis swaps referencing backward-looking rates. While it excels theoretically and includes numerical verification (accepted at SIAM Journal on Financial Mathematics), it lacks extensive empirical backtesting on historical market datasets.

Research Flowchart

  flowchart TD
    A["<b>Research Goal:</b> Price & hedge cross-currency basis swaps referencing backward-looking RFRs (SOFR vs AONIA)"] --> B["<b>Framework Setup:</b> Arbitrage-free cross-currency multi-curve framework"]
    
    C["<b>Data & Inputs:</b> RFRs (SOFR, AONIA) & Domestic/Foreign Collateral Settings"] --> B
    
    B --> D["<b>Pricing & Hedging Analysis:</b> Derive explicit formulas for constant notional CCBS"]
    
    D --> E["<b>Hedging Execution:</b> Calibrate hedging strategies using IR futures & currency futures"]
    
    E --> F["<b>Outcomes:</b> Explicit closed-form pricing & robust hedging methods for dual backward-looking RFR swaps"]

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  8. Cross-currency basis swaps referencing backward-looking rates — → 2410.08477
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1 of 45 cited works are in the corpus; resolved via arXiv source bundles, Semantic Scholar and OpenAlex. Corpus-wide: 2518 linked papers.