Rational savings account models for backward-looking interest rate benchmarks

Artikel

Interest rate benchmarks are currently undergoing a major transition. The LIBOR benchmark is planned to be discontinued by the end of 2021 and superseded by what ISDA calls an adjusted risk-free rate (RFR). ISDA has recently announced that the LIBOR replacement will most likely be constructed from a compounded running average of RFR overnight rates over a period matching the LIBOR tenor. This new backward-looking benchmark is markedly different when compared with LIBOR. It is measurable only at the end of the term in contrast to the forward-looking LIBOR, which is measurable at the start of the term. The RFR provides a simplification because the cash flows and the discount factors may be derived from the same discounting curve, thus avoiding-on a superficial level-any multi-curve complications. We develop a new class of savings account models and derive a novel interest rate system specifically designed to facilitate a high degree of tractability for the pricing of RFR-based fixed-income instruments. The rational form of the savings account models under the risk-neutral measure enables the pricing in closed form of caplets, swaptions and futures written on the backward-looking interest rate benchmark.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Journal: Risks ; ISSN: 2227-9091 ; Volume: 8 ; Year: 2020 ; Issue: 1 ; Pages: 1-18 ; Basel: MDPI

Classification and Topics

• Classification: Wirtschaft
• Subject: caplets ; futures ; LIBOR ; LIBOR transition ; rational term structure models ; risk-free rates ; SOFR ; SONIA ; swaptions

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Macrina, Andrea ; Skovmand, David
• Event: Veröffentlichung
• (who): MDPI
• (where): Basel
• (when): 2020

Further information

• DOI: doi:10.3390/risks8010023
• Handle: http://hdl.handle.net/10419/257978
• Last update: 10.03.2025, 11:43 AM CET