Is SOFR better than LIBOR?

Abstract

It is expected that in the near future USD LIBOR will be replaced by a rate based on SOFR. Loans indexed to LIBOR offer lenders insurance against funding shocks; SOFR does not have this property. In this paper, I develop a stylized model to study this mechanism and to take a first look at quantitative magnitudes. In my model, under normal conditions, an economy using SOFR behaves similarly to an economy using LIBOR. Under more extreme financial conditions, differences can be nontrivial.

Keywords: LIBOR, floating rates, TED spread

JEL Classification: G21, G29, E32