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

Frontiers of Mathematical Finance

66 Pages Posted: 27 Jun 2019 Last revised: 28 Mar 2023

See all articles by Alex Backwell

Alex Backwell

University of Cape Town

Andrea Macrina

University College London; University of Cape Town (UCT)

Erik Schlögl

University of Technology Sydney (UTS), Quantitative Finance Research Centre; University of Cape Town (UCT) - The African Institute of Financial Markets and Risk Management; Faculty of Science, Department of Statistics, University of Johannesburg; Financial Research Network (FIRN)

David Skovmand

University of Copenhagen

Date Written: June 5, 2019

Abstract

In the current LIBOR transition to overnight-rate benchmarks, it is important to understand theoretically and empirically what distinguishes actual term rates from overnight benchmarks or ``synthetic'' term rates based on such benchmarks. The well-known ``multi-curve'' phenomenon of tenor basis spreads between term structures associated with different payment frequencies provides key information on this distinction. This information can be extracted using a modelling framework based on the concept of ``roll-over risk'', i.e., the risk a borrower faces of not being able to refinance a loan at (or at a known spread to) a market benchmark rate. Separating the roll-over risk priced by tenor basis spreads into a credit-downgrade and a funding-liquidity component, the theoretical modelling and the empirical evidence show that proper term rates based on the new benchmarks remain elusive and that a multi-curve environment will persist even for rates secured by repurchase agreements.

Keywords: Roll-Over Risk, Multi-Curve Interest Rate Term Structure, OIS, IBOR, LIBOR Transition, Basis Swaps, Calibration

JEL Classification: C02, G12,

Suggested Citation

Backwell, Alex and Macrina, Andrea and Schloegl, Erik and Skovmand, David, Term Rates, Multicurve Term Structures and Overnight Rate Benchmarks: a Roll-Over Risk Approach (June 5, 2019). Frontiers of Mathematical Finance, Available at SSRN: https://ssrn.com/abstract=3399680 or http://dx.doi.org/10.2139/ssrn.3399680

Alex Backwell

University of Cape Town ( email )

University of Cape Town
Rondebosch
Cape Town, Western Cape 7700
South Africa

Andrea Macrina (Contact Author)

University College London ( email )

Gower Street
London, WC1E 6BT
United Kingdom

University of Cape Town (UCT) ( email )

Private Bag X3
Rondebosch, Western Cape 7701
South Africa

Erik Schloegl

University of Technology Sydney (UTS), Quantitative Finance Research Centre ( email )

Ultimo
PO Box 123
Sydney, NSW 2007
Australia
+61 2 9514 2535 (Phone)

HOME PAGE: http://www.schlogl.com

University of Cape Town (UCT) - The African Institute of Financial Markets and Risk Management ( email )

Leslie Commerce Building
Rondebosch
Cape Town, Western Cape 7700
South Africa

Faculty of Science, Department of Statistics, University of Johannesburg ( email )

Auckland Park, 2006
South Africa

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

David Skovmand

University of Copenhagen ( email )

Nørregade 10
Copenhagen, København DK-1165
Denmark

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