Work

Pricing and Hedging of SOFR Derivatives

Year: 2025

Type: article

Abstract: ABSTRACT The London Interbank Offered Rate (LIBOR) has served since the 1970s as a fundamental measure for floating term rates across multiple currencies and maturities. However, in 2017, the Financial Conduct Authority announced the discontinuation of LIBOR from the end of 2021, and the New York Fed declared the Treasury repo financing rate, called the Secured Overnight Financing Rate (SOFR), as a candidate for a new reference rate for IRSs denominated in U.S. dollars. We examine arbitrage‐free pricing and hedging of swaps referencing SOFR without and with collateral backing. As hedging instruments, we take SOFR futures and idiosyncratic funding rates for the hedge and margin account. For simplicity, a one‐factor model based on Vasicek's equation is used to specify the joint dynamics of several overnight interest rates, including the SOFR and unsecured funding rate.

Source: Mathematical Finance

DOI: 10.1111/mafi.70004

Authors: Matthew Bickersteth, Yining Ding, Marek Rutkowski

Institutions: The University of Sydney, Warsaw University of Technology

Language: English

Topic: Stochastic processes and financial applications

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: hybrid

Estimated APC paid: $3,840

Funder: Australian Research Council