Markets Evolution After the Credit Crunch

TL;DR

This paper reviews how the interbank and fixed income markets evolved after the 2007 financial crisis, highlighting changes in basis spreads, collateral practices, and derivative pricing paradigms.

Contribution

It provides a comprehensive analysis of post-crisis market changes, especially in basis divergence, collateral agreements, and the shift to CSA discounting for derivatives.

Findings

Divergence of Libor and OIS basis after 2007 crisis

Increased adoption of collateral agreements in OTC derivatives

Shift to CSA discounting as the new market standard

Abstract

We review the main changes in the interbank market after the financial crisis started in August 2007. In particular, we focus on the fixed income market and we analyse the most relevant empirical evidences regarding the divergence of the existing basis between interbank rates with different tenor, such as Libor and OIS. We also discuss a qualitative explanation of these effects based on the consideration of credit and liquidity variables. Then, we focus our attention on the diffusion of collateral agreements among OTC derivatives market counterparties, and on the consequent change of paradigm for pricing derivatives. We illustrate the main qualitative features of the new market practice, called CSA discounting, and we point out the most relevant issues for market players associated to its adoption.