Year: 2021
Type: article
Abstract: The London InterBank Offered Rate is scheduled for discontinuation, and the replacement advocated by US regulators is the Secured Overnight Financing Rate (SOFR). The only SOFR‐linked derivative with significant liquidity and trading history is the SOFR futures contract, traded at the Chicago Mercantile Exchange. We use the historical record of futures prices to construct dynamic arbitrage‐free models for the SOFR term structure. We find that a Gaussian arbitrage‐free Nelson–Siegel model describes term structure well without accounting for jumps and seasonal effects observed in SOFR. However, a shadow‐rate extension is needed to describe volatility near the zero‐boundary impacting the futures convexity adjustment and option pricing.
Source: Journal of Futures Markets
DOI: 10.1002/fut.22246
Authors: Jacob Bjerre Skov, David Skovmand
Institution: University of Copenhagen
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W3175696915