Building a Money Market Curve Without Liquid Swaps

Summary

The document frames a curve-construction problem for valuing repos, loans, and deposits in a local currency market without a liquid overnight index swap market. Available inputs include a published overnight repo index average and weighted average interbank loan and deposit rates. Treasury bills have historically served as a proxy, but are considered potentially unrepresentative of interbank funding conditions. The proposed alternative is to compound the daily overnight index rate into a curve. The question raises a risk management concern: relying on a single overnight point may fail to capture term-specific behavior, including relationships between tenor rates. No answer, tested methodology, or market evidence is provided, so the document establishes the problem rather than resolving it. Any practical approach would need to address how sparse term information is incorporated and how resulting curve behavior is validated.

Key ideas

• The curve is intended to value repos, loans, and deposits in a market without liquid overnight swaps.
• Treasury bills may not reflect interbank liquidity or money market activity accurately.
• Compounding the overnight index average offers a possible curve-building starting point.
• A curve projected from one overnight rate may omit term-specific relationships and risk behavior.

Tags

# Constructing a Money Market Yield Curve in an Illiquid Market: Compounded ONIA vs. Treasury Proxies


# Constructing a Money Market Yield Curve in an Illiquid Market: Compounded ONIA vs. Treasury Proxies












I am currently developing a money market curve framework for the valuation of Repo instruments, Loans, and Deposits in a local currency market.

Our market currently lacks a liquid Overnight Index Swap market.

The Central Bank publishes a daily Repo Overnight Index Average rate, as well as weighted average rates for interbank loans and deposits.

Historically, we have used the Treasury Bill curve as a proxy for the money market.However, we are being challenged to move away from T-Bills on the basis that they do not accurately represent interbank liquidity or money market operations.

The proposed alternative is to construct a curve based on the compounding of the daily ONIA rate.

From a risk management perspective, I have reservations regarding this.Since the curve would essentially be a projection of a single daily point (the ONIA) compounded forward, it risks errase any negative correlation between tenors.

Question: Are there alternative methodologies for constructing a representative money market curve in an environment where ONIA is the only liquid benchmark, but a T-Bill proxy is deemed unrepresentative? How can we incorporate a term structure without a liquid swap market?

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.