2021/12/28 by Matthew Bickersteth, Bickersteth, Matthew, Ding, Yining +2 · 2 citations
Economics, Econometrics and Finance · #91G20 #91G40 #FOS: Economics and business #Financial Markets and Investment Strategies #Market Dynamics and Volatility #Mathematical Finance (q-fin.MF) #Stochastic processes and financial applications
paper · pdf · doi:10.48550/arxiv.2112.14033
openalex publication_date 2021/12/28 · openalex created_date 2022/05/05 · openalex updated_date 2026/07/31
The LIBOR has served since the 1970s as a fundamental measure for floating term rates across multiple currencies and maturities. However, in 2017 the Financial Conduct Authority announced the discontinuation of LIBOR from the end of 2021 and the New York Fed declared the Treasury repo financing rate, called the Secured Overnight Financing Rate (SOFR), as a candidate for a new reference rate for interest rate swaps denominated in U.S. dollars. We examine arbitrage-free pricing and hedging of swaps referencing SOFR without and with collateral backing. As hedging instruments, we take SOFR futures and idiosyncratic funding rates for the hedge and margin account. For simplicity, a one-factor model based on Vasicek's equation is used to specify the joint dynamics of several overnight interest rates, including the SOFR and unsecured funding rate.