FED Report on Feasibility of Inferring Term Rates from SOFR Futures
FED published a staff working paper that examines the feasibility of using Secured Overnight Financing Rate (SOFR) futures prices to construct forward-looking term reference rates that are conceptually similar to the term London Inter-bank Offered Rate (LIBOR) rates commonly used in loan contracts. The Alternative Reference Rate Committee, which constitutes a group of private-sector market participants and is convened by FED, has recommended that markets transition to the use of SOFR in financial contracts that currently reference US dollar LIBOR.
The paper describes the empirical approach used in the study and presents estimated term rates derived from closing prices on CME SOFR futures. The estimated term SOFR rates have closely tracked federal funds Overnight Index Swap (OIS) rates over the eight months since SOFR futures began trading. Finally, the paper summarizes the conclusions of the study and discusses potential extensions and improvements to the approach developed here. Appendix A to this paper presents technical details of the presented approach.
To examine the performance of futures-implied term rates over a longer time horizon, the report presents estimates of term rates using federal funds futures from 2000 to the present. Consistent with prior research, it was found that futures-implied term rates are good predictors of realized compounded overnight rates during most periods; however, like other forward-looking term rates, including OIS and LIBOR, they were slow to adjust to rapidly falling overnight rates during the first months of the financial crisis.
Related Link: Working Paper (PDF)
Keywords: Americas, US, Banking, Interest Rate Risk, Risk Free Rate, Interest Rate Benchmarks, LIBOR, SOFR, Research, Alternative Reference Rate Committee, FED
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