Building a SOFR Curve with Futures and Libor–SOFR Basis Swaps

Summary

The answer describes a historical approach to constructing a SOFR term structure while direct SOFR instruments were still developing. SOFR itself is an overnight rate, so curve construction relies on market instruments that reveal expectations or spreads over longer horizons. The proposed inputs are SOFR futures for the short end and Libor–SOFR basis swaps for maturities beyond the futures strip, with the swaps described as reasonably liquid to around five years and quoted farther out.

The response says that, at the time, the resulting SOFR curve was close to the Fed Funds curve because the overnight rates were usually similar. It also expected SOFR liquidity to improve and standard swaps eventually to move from Libor to SOFR. Those comments are explicitly time-dependent expectations from the period discussed, not current market guidance. The document does not provide bootstrapping equations, curve conventions, or a procedure for projecting cash flows beyond liquid instruments; long-end construction and basis, liquidity, and model risks therefore remain unresolved in this brief answer.

Key ideas

• The described curve uses SOFR futures to inform the short end.
• Libor–SOFR basis swaps are presented as inputs for extending the curve beyond futures maturities.
• At the time described, the SOFR and Fed Funds curves were said to be close because their overnight rates were similar.
• Expectations about future liquidity and standard SOFR swap adoption are historical and may no longer apply.
• The answer does not specify detailed bootstrapping conventions or a long-end projection method.

Tags

# SOFR term structure


# SOFR term structure












Recently I have been going through a lot of documents for SOFR (Secured Overnight Financing Rate) as there is a SOFR implementation in my organization. I am not able to understand how SOFR term structure will be build. SOFR is published only for 1 day and there are only 20 SOFR futures traded.

How will be the forecasting of cash flows after 5 years happen? What underlyings will be used to do bootstrapping for generating a SOFR EOD term structure?

## Answer by dm63 (score 5)

https://quant.stackexchange.com/a/50915

At this point liquidity in SOFR is provided by a set of futures contracts in the very short end of the curve , and then through Libor -SOFR basis swaps which are reasonably liquid up to around 5years, although quotations exist up to 30yrs. You can build a curve using these basis swaps. Currently , the SOFR curve differs from the Fed Funds curve by only a few Bp, which isn’t too surprising given that the overnight setting of SOFR is usually very close to overnight Fed Funds.

Most participants think that liquidity will build over time so that SOFR will be quite liquid by year end 2020. Eventually it is expected that the standard swap quote will be against SOFR rather than Libor , but that may be 2-3 years down the road.

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.