Term Rates, Multicurve Term Structures and Overnight Rate Benchmarks: a Roll-Over Risk Approach

Alex Backwell; Andrea Macrina; Erik Schloegl; David Skovmand

doi:10.2139/ssrn.3399680

Term Rates, Multicurve Term Structures and Overnight Rate Benchmarks: a Roll-Over Risk Approach

Alex Backwell, Andrea Macrina, Erik Schloegl, David Skovmand

Department of Mathematical Sciences

Abstract

Modelling the risk that a financial institution may not be able to roll over short-term borrowing at the market reference rate, we derive the dynamics of (interbank) reference term rates (e.g., LIBOR) and their spread vis-à-vis benchmarks based on overnight reference rates, e.g., rates implied by overnight index swaps (OIS). This is particularly relevant to the current debate around the transition of replacing the former by the latter. The model endogenously generates different interest rate term structures for each tenor, that is, for each different choice of the length of the interest rate accrual period, be it overnight (e.g., OIS), three–month LIBOR, six–month LIBOR, etc. We show that it can be calibrated simultaneously to available market instruments at a particular point in time, and the model interpolates the market for basis spreads of different tenors well, giving confidence for the use of the model to price bespoke tenors relative to the market.

Original language	Danish
DOIs	https://doi.org/10.2139/ssrn.3399680
Publication status	Published - 27 Jun 2019

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10.2139/ssrn.3399680

Cite this

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title = "Term Rates, Multicurve Term Structures and Overnight Rate Benchmarks: a Roll-Over Risk Approach",

abstract = "Modelling the risk that a financial institution may not be able to roll over short-term borrowing at the market reference rate, we derive the dynamics of (interbank) reference term rates (e.g., LIBOR) and their spread vis-{\`a}-vis benchmarks based on overnight reference rates, e.g., rates implied by overnight index swaps (OIS). This is particularly relevant to the current debate around the transition of replacing the former by the latter. The model endogenously generates different interest rate term structures for each tenor, that is, for each different choice of the length of the interest rate accrual period, be it overnight (e.g., OIS), three–month LIBOR, six–month LIBOR, etc. We show that it can be calibrated simultaneously to available market instruments at a particular point in time, and the model interpolates the market for basis spreads of different tenors well, giving confidence for the use of the model to price bespoke tenors relative to the market.",

keywords = "Roll-Over Risk, Multi-Curve Interest Rate Term Structure, OIS, IBOR, LIBOR Transition, Basis Swaps, Calibration",

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AU - Macrina, Andrea

AU - Schloegl, Erik

AU - Skovmand, David

PY - 2019/6/27

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N2 - Modelling the risk that a financial institution may not be able to roll over short-term borrowing at the market reference rate, we derive the dynamics of (interbank) reference term rates (e.g., LIBOR) and their spread vis-à-vis benchmarks based on overnight reference rates, e.g., rates implied by overnight index swaps (OIS). This is particularly relevant to the current debate around the transition of replacing the former by the latter. The model endogenously generates different interest rate term structures for each tenor, that is, for each different choice of the length of the interest rate accrual period, be it overnight (e.g., OIS), three–month LIBOR, six–month LIBOR, etc. We show that it can be calibrated simultaneously to available market instruments at a particular point in time, and the model interpolates the market for basis spreads of different tenors well, giving confidence for the use of the model to price bespoke tenors relative to the market.

AB - Modelling the risk that a financial institution may not be able to roll over short-term borrowing at the market reference rate, we derive the dynamics of (interbank) reference term rates (e.g., LIBOR) and their spread vis-à-vis benchmarks based on overnight reference rates, e.g., rates implied by overnight index swaps (OIS). This is particularly relevant to the current debate around the transition of replacing the former by the latter. The model endogenously generates different interest rate term structures for each tenor, that is, for each different choice of the length of the interest rate accrual period, be it overnight (e.g., OIS), three–month LIBOR, six–month LIBOR, etc. We show that it can be calibrated simultaneously to available market instruments at a particular point in time, and the model interpolates the market for basis spreads of different tenors well, giving confidence for the use of the model to price bespoke tenors relative to the market.

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KW - Multi-Curve Interest Rate Term Structure

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KW - IBOR

KW - LIBOR Transition

KW - Basis Swaps

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