Caplet pricing in affine models for alternative risk-free rates

TL;DR

This paper develops explicit valuation formulas for various interest rate derivatives within a general affine process model for alternative risk-free rates, aiding in accurate pricing and risk management.

Contribution

It introduces a flexible affine process framework for RFRs and derives explicit formulas for caplets, floorlets, and futures, enhancing modeling accuracy.

Findings

Explicit formulas for caplet and floorlet prices

Valuation of RFR futures contracts

Flexible affine model for RFRs

Abstract

Alternative risk-free rates (RFRs) play a central role in the reform of interest rate benchmarks. We study a model for RFRs driven by a general affine process. Under minimal assumptions, we derive explicit valuation formulas for forward-looking and backward-looking caplets/floorlets, term-basis caplets as well as 1-month and 3-month RFR futures contracts.