Quantitative Impacts of Replacing LIBOR with Overnight Benchmarks
Summary
The document outlines quantitative and market changes that may follow the replacement of interbank benchmarks such as LIBOR with alternative rates. It names SOFR for US dollar markets and SARON for Swiss franc markets, and notes that adoption and liquidity can vary. It also cites an argument for preferring overnight indexed swap rates over LIBOR as risk-free benchmarks in derivatives pricing.
For swaps referencing SOFR, the response highlights daily rate projection and compounding, choices between Fed Funds and SOFR discounting, and the lack of historical SOFR swap data for estimating swaption volatility or calculating VaR. It notes that SOFR futures had been launched but had low volume at the time described. As swap liquidity grows, the missing data may become available. The discussion is an early transition snapshot rather than a complete implementation guide; benchmark adoption, contract conventions, discounting practice, and data availability can change over time and by market.
Key ideas
- Benchmark replacement affects curve construction, derivatives pricing, risk measurement, and market data.
- SOFR and SARON are examples of alternatives to legacy interbank benchmarks.
- SOFR swaps require daily rate projection and compounding rather than quarterly LIBOR projection.
- Discounting conventions may differ across contracts, including between Fed Funds and SOFR.
- Limited historical swap data constrains volatility estimation for swaptions and VaR calculations.
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Full text
# What are the impacts of the discontinuation of benchmark Interest Rates? # What are the impacts of the discontinuation of benchmark Interest Rates? I was wondering what the impacts of Interest Rates benchmarks (LIBOR/EURIBOR) discontinuation might be on the Quants side ? Do you know if there are articles/discussions providing an analysis grid of potential impacts (discounting, swap/options pricing, VaR time series, ...) Thanks in advance ## Answer by pyCthon (score 2) https://quant.stackexchange.com/a/40904 Most regulatory/central bank bodies are starting to offer alternatives that the market may or may not adopt. With the USD we have a new market derived measure called SOFR. For the CHF we now have SARON. CME group has also launched SOFR futures, albeit low volume. ## Answer by Igor Pozdeev (score 1) https://quant.stackexchange.com/a/40916 There's a paper providing formal arguments why OIS rates should be favored over LIBOR as risk-free benchmarks for derivatives pricing: Hull and White (2013). ## Answer by dm63 (score 0) https://quant.stackexchange.com/a/40914 In the US, the clearing houses have announced a new swap contract which is a fixed rate versus SOFR, which is a repo based rate that will be observed and compounded daily, paid probably annually or perhaps quarterly. Thus raises a number of quant type issues: (1) daily projection of SOFR will be required , as opposed to quarterly projection in today's Libor swaps. (2) discounting is yet to be decided, but some contracts will be discounted at FedFunds whilst others could be discounted at SOFR. (3). There's not yet any data series for SOFR based swaps, so there's no historical volatility to help price SOFR swaptions, and no data series to calculate Var. As SOFR swaps gain liquidity, presumably this will gradually be solved.
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