A Libor market model with a stochastic basis

A Libor market model with a stochastic basis

The 2007 credit crunch brought unprecedented levels and volatility of basis spreads in the interest rate market. Classic no-arbitrage rules broke down and rates that used to closely track each other suddenly diverged. Discrepancies between theoretically equivalent rates were present in the market even before 2007. For instance, deposit rates and overnight indexed swap (OIS) rates for the same maturity had always been a few basis points apart. Likewise, swap rates with the same maturity, but

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