Dual-Curve Bootstrapping: Why Convention Consistency Matters for EUR Swap Pricing

The Dual-Curve Framework

Since the 2008 financial crisis, the interest rate derivatives market has undergone a fundamental structural shift. The pre-crisis assumption that a single yield curve could simultaneously serve as both the discounting and forecasting curve has been definitively abandoned. Today, EUR swap pricing requires a rigorous dual-curve framework: an OIS curve built from ESTR overnight index swaps for discounting, and a separate Euribor curve for projecting forward rates.

This separation introduces a layer of complexity that is often underestimated. The OIS curve captures the risk-free (or near risk-free) time value of money, while the Euribor curve embeds the term credit and liquidity premia inherent in unsecured interbank lending. Getting both curves right — and ensuring they interact correctly — is the foundation upon which all EUR swap valuations rest.

Compounding Convention Mismatches

One of the most subtle yet impactful sources of pricing error lies in compounding convention mismatches during the bootstrapping process. The ESTR OIS market quotes instruments with annual compounding for maturities beyond one year, while Euribor swaps reference a quarterly or semi-annual floating leg depending on the tenor. When bootstrapping algorithms fail to align these conventions — for instance, applying continuous compounding to an instrument quoted under annual compounding — the resulting discount factors carry a systematic bias.

In our work at Bell Capital, we have observed that convention mismatches can introduce pricing errors of 0.5 to 2 basis points on a 10-year EUR IRS. While this may seem small in isolation, for a portfolio with €500 million in notional, this translates to a present value discrepancy of €250,000 to €1 million. For institutional portfolios running into the billions, the cumulative impact on NPV and risk metrics such as DV01 becomes material.

TARGET Calendar and Payment Alignment

A further complication specific to EUR markets is the TARGET calendar. All ESTR fixings and OIS cash flows settle according to the TARGET holiday schedule, which differs from national calendars. Bootstrapping engines must correctly handle date adjustments — modified following business day conventions, end-of-month rules, and the stub period treatment at the short end of the curve.

We have found that many off-the-shelf curve construction libraries default to simplified date logic that does not fully respect TARGET calendar nuances. The result is a curve that appears smooth but carries embedded date misalignment errors, particularly around year-end turns and ECB meeting dates where overnight rate expectations shift sharply.

Practical Implications

For practitioners managing EUR interest rate books, the takeaway is clear: convention consistency is not a theoretical nicety but a practical necessity. Every assumption in the bootstrapping chain — day count conventions, compounding frequencies, interpolation methods, and calendar rules — must be internally consistent and aligned with market quoting conventions. At Bell Capital, our Adamix platform enforces this consistency by construction, ensuring that the pricing engines powering our quantitative consultancy and the analytical backbone supporting our valuation work both operate from a single, rigorously calibrated curve framework.