SOFR Term Rates From Treasury Repo Pricing

Forthcoming, Journal of Derivatives, Summer 2022

Posted: 1 Mar 2021 Last revised: 5 Jul 2022

Date Written: December 25, 2020

Abstract

The Secured Overnight Financing Rate (SOFR) is on a finishing path to replace US dollar LIBOR. A key issue remains, however, namely the lack of credit sensitive, termed rates equivalent to LIBOR rates. Back to SOFR’s root in the Treasury repo market, we compute SOFR term rates by pricing Treasury repos across different tenors. Recognizing that SOFR mixes in different segments of the overnight market, term rates are computed per segment and a volume weighted average is taken as the SOFR term rate. The tri-party segment shows three-month repo spread of 45 basis points during the global financial crisis, and the bilateral segment has 59 bps. Contrary to the new risk-free-rates label, we show that SOFR has a credit component, but it is not strong enough for the purposes of replacing LIBOR in the corporate and consumer lending markets. A credit sensitive benchmark is still needed to fully replace LIBOR.

Keywords: SOFR Term Rate, Treasury Repo Pricing, LIBOR Transition, SOFR Composition

JEL Classification: G12, G18, G23, G24, G33

Suggested Citation

Lou, Wujiang, SOFR Term Rates From Treasury Repo Pricing (December 25, 2020). Forthcoming, Journal of Derivatives, Summer 2022, Available at SSRN: https://ssrn.com/abstract=3776832 or http://dx.doi.org/10.2139/ssrn.3776832

Wujiang Lou (Contact Author)

NYU/Courant ( email )

251 Mercer St
New York, NY 10003-711
United States

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