Insight Post
A Stylized History of the Risk-Free Rate Transition
By Tom P. Davis, PhD, CFA | August 18, 2020
Although there have been many consultations, announcements, and discussions with various regulatory boards (the ARRC, the FCA), there is still uncertainty around aspects of the LIBOR transition.
Insight Post
The End of LIBOR is Nigh
By Tom P. Davis, PhD, CFA | October 31, 2018
The London Interbank Offered Rate (LIBOR) has been a mainstay of the financial markets since its inception in the 1980s as an underpinning of the then nascent swap market. Since then, LIBOR has gained fame, and more recently notoriety, and is the reference rate for over $240 trillion in securities globally.
The shortcomings of LIBOR were not initially apparent, hence the exponential growth in securities that used LIBOR as a reference rate. However, throughout its lifetime, two LIBOR shortcomings arose.
INSIGHT POST
Beware the Ides of September: Update on the SOFR Transition
By Tom P. Davis, PhD, CFA | October 31, 2019
In a previous insight article, we discussed the fact that the Alternative Reference Rate Committee (ARRC) chose the Secured Overnight Financing Rate (SOFR) as the replacement for USD LIBOR. In April of 2018, the NY Fed began officially reporting this rate, and the market started observing its dynamics. SOFR is a volume weighted median of tri-party repo transactions. Since it is determined by market transactions, the rate is affected by supply and demand, which is driven by daily bank operations and bank intervention. The overnight repo market is especially active at month and quarter end. This effect, called the “turn”, is well known in money markets.
WHITE PAPER
The LIBOR Market Model and Mortgage Analytics at FactSet
The valuation of structured products relies on projected prepayments, which in turn rely heavily on the realized path of the mortgage rate. Any stochastic interest rate model must reflect the important empirical behavior that affects the prepayments. A critical behavior of the model is to show high serial correlation of the 10-yr swap rate, which plays a central role in the determination of the mortgage rate.
In this white paper, we explore the LIBOR market model (LMM) and its superiority to a multifactor short rate model when reproducing this serial correlation.
INSIGHT POST
Forward-Looking Forward Rates: The Term SOFR Paradoxes
By Xi (Figo) Liu, CFA | November 30, 2021
In 2017, the Alternative Reference Rate Committee (ARRC) chose the Secured Overnight Financing Rate (SOFR) as the replacement for USD LIBOR. Since this announcement, the LIBOR transition has been making steady progress. As part of this transition, term SOFR has been requested by market participants so that it can be referenced in financial contracts in the same way as LIBOR term rates.
Initially, the proposed scope of usage for term SOFR was limited and discouraged. However, as the market evolved, it allowed for term SOFR to potentially be referenced more broadly than originally designed. With a wider scope of usage, it is worth discussing the issues that could arise with term SOFR.
