In the conluding interview of FINCAD’s interview series, John Hull, PhD and Alan White, PhD opine on how buy-side firms can best prepare for unexpected phenomena like OIS, negative rates and the LCH-CME basis.
“Before the crisis, we could adopt the position that banks were essentially riskless. Post-2008, it has become clear that this not the case,” commented White. “As a result, banks could no longer use Libor as a proxy for the risk-free rate. This transition has been very difficult. What this means is that it is becoming more and more important to have a flexible system that allows you to make these and other important changes relatively easily.” White described that while it’s not technically difficult to change from Libor over to OIS discounting, it does require adjusting everything that you do. The sheer volume of these changes makes technology flexibility a necessity for buy-side firms.
Hull agreed with White’s remarks concerning flexibility in trading and risk systems saying that, “we have to think as widely as we can about the things that might change going forward.” Hull went on to offer up a contrasting viewpoint on the Libor versus OIS discounting dilemma. He remarked, “If you talk to an academic, they will likely give you the answer that Alan gave—that is, OIS is a better proxy for the risk-free rate than is Libor. But often when you talk to market practitioners what they’ll say is there is no such thing as the risk-free rate.”
Check out our video to get the full discussion.