SOFR Curve Construction and Cash-Flow Conventions
Summary
The document compares SOFR curve construction and cash-flow projection with legacy IBOR approaches. One answer says curve building still depends on the available liquid market inputs and chosen interpolation, while projecting cash flows follows the rate’s accrual formula. For overnight rates such as SOFR, that involves compounding daily fixings; fallback LIBOR projections may add a fixed spread to compounded rates. The discussion also flags the importance of observation lags when selecting fixings for coupon periods.
A second answer cautions that the transition can require substantial implementation changes because SOFR is an overnight rate without LIBOR’s term credit component. It mentions differences in cash-flow and accrual conventions, curve calibration instruments, and cap volatility treatment. The document does not explain the Bloomberg first-pillar date in detail or provide a step-by-step bootstrap method. Its answers offer a useful high-level overview, but conventions depend on the instrument and market implementation.
Key ideas
- Curve construction depends on liquid calibration instruments and the interpolation method chosen.
- SOFR cash flows generally use compounded daily overnight fixings.
- Fallback LIBOR projections may combine compounded rates with a fixed spread.
- Observation lags determine which daily fixings enter a coupon accrual period.
- Moving from LIBOR can affect curve instruments, accrual conventions, cash flows, and volatility inputs.
Tags
Full text
# SOFR Transition # SOFR Transition I have few doubts regarding transition from IBOR to SOFR rates. - How will the method of calculating/estimating curve rates change after changing to SOFR? - Will there be any change in valuation methodology in plotting future cash flows or will the existing methodology continue? - In Bloomberg, the curve for fixed-floating SOFR shows the date for first tenor as valuation day +3. For example the curve for 1st March shows first pillar date for on rare as 4 April. What is the reason for that? ## Answer by Attack68 (score 5) https://quant.stackexchange.com/a/65501 - SOFR is just an index, like FedFunds or LIBOR, there is no fundamentally different schema for creating a curve. It involves exactly the same considerations you will make as if you are constructing a LIBOR or FFOIS curve, namely: - what input prices are available and liquid for calibrating the curve(set). - what interpolation scheme is best to employ for each curve (part of curve). - For projecting future cashflows there is no difference. Once the SOFR curve is available you project cashflows according the to formula that determines them. I.e a 3M FFOIS forward uses compounded daily FFOIS fixings. The same is true for SOFR. For forecasting a fallback LIBOR this will also involve a fixed spread addition to the compounded rates. - You will have to be careful about lags on the new SOFR on, for example, bond coupon flows referencing SOFR and fallback libor. But essentially this just defines which fixings to use for which period to compound. ## Answer by Tim Glauner (score 2) https://quant.stackexchange.com/a/69253 It's true that SOFR is very similar to OIS Fed Fund swaps but for LIBOR conversion I think there will be a lot to it. There will be many differences as the SOFR rate is an overnight rate with no credit risk and LIBOR is a term rate with credit being part of the rate. The differences will show up in cashflow calculation methods, accrual methods, curve bootstrapping (2 futures - one averaging/one compounding, vols for caps (current period is partly fixed). It's really too numerous to list all here. I have done now half a dozen conversions (non USD mostly) and a lot of the work is in new curves and cashflows/accruals. Maybe the udemy class which is 3.5 hours might be useful as it gives a broad overview, then talks about transition, then cashflow conventions and then curve building. Have a look at the course as I think it will provide useful information https://www.udemy.com/course/the-libor-transition-for-capital-markets-practitioners/?referralCode=148E509D751C43A12F88
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