Abstract:
Financial crisis of 2007-2008 changed the assumptions underlying market models theoretically and in practice.
Therefore, this research focuses on modelling the impact of interest rate financial crisis. The aim was to describe
pricing of financial derivatives mainly interest rate swap pricing method used under both pre and post crisis period.
To model riskless rate/short rate and credit risk factors in the interbank market as well as price a defaultable zero
coupon bond with credit adjustment. Riskless rate was modelled by use of a no arbitrage model CIR++ model
while default intensity simulation was modelled following a Monte-Carlo method using stochastic processes
(CIR) for parameterization. In simulating short rate exact method of simulation was used by assuming that
CIR++ model increments follow a non- central chi-square distribution and model parameters estimated by use of
maximum likelihood method. Both pre and post crisis period parameters were estimated and compared to analyse
the impact of the crisis.In modelling credit risk reduced form modelling approach was used and CIR model used
to model default intensity. For default intensity simulation Euler scheme method was used for discretization.
