Settlement Curve Evaluation for Interest Rate Swap Valuation
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Solution Overview
Problem
The determination of settlement values in interest rate swaps often results in poorly behaved settlement curves, leading to nonsensical results due to negative discount factors, which are undesirable and require correction.
Innovation Solution
A method is introduced to evaluate settlement curves by determining if the difference between consecutive settlement values exceeds a threshold, allowing for adjustments or recalculations to prevent negative discount factors, including generating error codes or adjusting settlement values by a predetermined number of basis points.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Reliability
If settlement values are determined using conventional methods, then the settlement curve can be generated, but negative discount factors occur leading to nonsensical results
Solution Approach 1:
The patent applies preliminary action by evaluating the settlement curve before finalizing discount factors. The system checks whether the settlement curve is 'well-behaved' (monotonically decreasing) and predicts whether discount factors would be negative before they are actually used. This allows preventive correction of the settlement curve to avoid generating invalid negative discount factors in the first place.
Solution Approach 2:
The patent implements feedback by using the evaluated settlement curve information to adjust and correct settlement values. When the system detects that the settlement curve is not well-behaved or would produce negative discount factors, it feeds this information back to modify the settlement curve, ensuring that corrections are made based on actual performance data rather than proceeding with invalid values.
2Reliability
If settlement curves are evaluated and adjusted, then negative discount factors are prevented, but additional processing steps and error code generation are required
Solution Approach 1:
The patent evaluates settlement curves and generates error codes in advance before discount factors are finalized or used in transactions. By performing this validation and correction process preliminarily, the system avoids the need for complex post-processing and error handling after discount factors have been generated, thereby reducing overall system complexity despite the added evaluation step.
Data Source
AI summary
Disclosed is a method that is useful in connection with providing discount factors for an exchange-traded mark-to-market derivative product that has a variable tick rate, such as an interest rate swap product. In some embodiments, the method includes providing a series of consecutive settlement values, which collectively represent a settlement value curve for the derivative product. The curve is evaluated by determining, for each consecutive pair of settlement values, whether the difference between the first settlement value in the pair and the second settlement value in the pair exceeds a threshold. The threshold represents the value at which a discount factor derived from said pair of settlement values, in conjunction with other parameters, would be negative. In other embodiments the disclosed invention encompasses an apparatus and a computer-readable medium.