Choosing IOER or Fed Funds OIS for USD Derivatives Discounting

Summary

The document asks how to build a USD multi-curve setup for trading Fed Funds and Eurodollar futures, with Fed Funds and three-month LIBOR forecast curves. It compares discounting from an OIS curve based on effective Fed Funds with using the Interest on Excess Reserves (IOER) rate as the discounting basis, potentially accounting for the spread between effective Fed Funds and IOER.

The rationale for considering IOER is that it is paid on reserves held at the Federal Reserve, while effective Fed Funds reflects unsecured overnight lending and may be lower. The author also notes that IOER may be relevant to CME margin remuneration. The text poses the modeling choice but does not resolve it or provide calibration results. The appropriate setup therefore remains dependent on the instruments, collateral and margin conventions, and the intended pricing framework; the discussion alone is not enough to establish which curve is theoretically preferable for a particular futures strategy.

Key ideas

• The proposed multi-curve setup uses Fed Funds and three-month LIBOR for forecasting.
• The question is whether effective Fed Funds OIS should also serve as the discount curve.
• IOER is presented as an alternative discounting basis because it is paid on reserves at the Federal Reserve.
• The text notes a possible spread between effective Fed Funds and IOER, but does not prescribe a curve choice.

Tags

# USD MultiCurve Calibration - IOER vs. OIS/Fed Funds


# USD MultiCurve Calibration - IOER vs. OIS/Fed Funds












I'm building out a calibrated USD MultiCurve set, focusing on Fed Funds & 3M LIBOR for the purpose of trading in Fed Funds Futures and Eurodollar Futures (for now ...).

I had always assumed that the OIS/Fed Funds rate (perhaps with a turn-of-calendar spread adjustment) was used as the discounting curve itself. In reading Darbyshire's excellent Pricing and Trading Interest Rate Derivatives, I came across another rate (the Interest on Excess Reserves) that seems to have some merit as the true discounting basis.

- It is truly a risk-free rate, being the interest on deposits held at the Fed rather than unsecured overnight lending.

- It is, I believe, the interest offered on margin at the CME.

On the other hand, due to the fact that the Fed Funds rate reflects lower-than-IOER loans made from banks unable to earn interest on reserves to US Branches of Foreign Banks, the Effective Fed Funds rate is often lower than the IOER.

Question: given my interest in trading futures, which is the more theoretically sound USD MultiCurve setup?

- OIS/Fed Funds forecasting + 3M Libor forecasting, with an EFFR vs. IOER spread to the discounting curve, or

- OIS/Fed Funds (forecasting + discounting) + 3M Libor forecasting.

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.