Year: 2025
Type: article
Abstract: SOFR derivatives market remains illiquid and incomplete, so it is not amenable to classical risk-neutral term structure models which are based on the assumption of perfect liquidity and completeness. This paper develops a statistical SOFR term structure model that is well-suited for use in risk management and derivatives pricing models within the incomplete markets paradigm. The model incorporates relevant macroeconomic factors that drive central bank policy rates which, in turn, cause jumps often observed in the SOFR rates. The model is easy to calibrate to historical data, current market quotes, and the user's views concerning the future development of the relevant macroeconomic factors. The model is well suited for large-scale simulations often required in risk management, portfolio optimization and indifference pricing of interest rate derivatives.
Source: Applied Mathematical Finance
Authors: Teemu Pennanen, Waleed Taoum
Institution: King's College London
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: hybrid
Funder: UK Research and Innovation
OpenAlex ID: W6948254285
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