THE ARBITRAGE-FREE VALUATION AND HEDGING OF DEMAND DEPOSITS AND CREDIT CARD LOANS

Using a market segmentation argument, this paper uses the interest rat e derivative's arbitrage-free methodology to value both demand deposit liabilities and credit card loan balances in markets where deposits/l oan rates may be determined under imperfect competition. In this conte xt, these financial instruments are shown to be equivalent to a partic ular interest rate swap, where the principal depends on the past histo ry of market rates. Solutions are obtained which are independent of an y particular model for the evolution of the term structure of interest rates. (C) 1998 Elsevier Science B.V. All rights reserved.