<aside> 💡 Interest rate swaps are well stablished fixed income contracts in traditional finance. However, many of the traditionally trivial steps when pricing interest rate swaps are extremely hard in the context of Decentralized Finance (DeFi).
In this paper we propose a method to estimate the one, two and three months interest rates in the DeFi credit markets.
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Section 1 (Pricing Strategy) we define the problem we are trying to solve. In this section we define the idea of the fair pricing of interest rates swaps versus the portfolio exposure.
1. Pricing Strategy Explained (Base Spread & DemandSpread)
Section 2 (The shape of the model) we define the model we will calibrate against the historical data to estimate the one month interest rate. The model in this section is a combined clustering step with a series of linear models per cluster.
2. The shape of the Base Spread Model
In section 3 (Yield Curve) we study the historical observed yield curve and we construct a probability distribution for the two and three months interest rate.
Section 4 (Risk Management) we describe our findings from our multi-agent simulation, including recommendations for parameter fine-tuning.