Multi-yield Curve Modeling (with Application To Kenyan Bond Market)

Abstract

We discuss post-credit crunch paradigm shift from single-curve to the multi-curve setting. We first present the single curve, where we try to enrich the exposition by providing the requisite basic financial background. We explore techniques such as the construction of single yield (spot) curve, and show how we obtain yield measures from the curve. We then look at how the interest rate swaps are priced under single-curve pricing methodology. We further study the multi-curve pricing framework. This is done by constructing the single discounting curve, then the multiple forwarding curves while are used to compute forward rates and the cash flows. The discounting curve is then used to compute the discount factors and the cash flows relevant for pricing the interest rate swaps. For our analysis, we use both single yield curve- and multi-curve pricing frameworks discussed above to price the bonds offered in Kenyan market, by calculating the yield rates. We use data from Central Bank of Kenya. We then compare the prices using the two methodologies of pricing, with the pricing methodology applied by the market and give conclusions and recommendations.