By Tom P. Davis, PhD, CFA | August 18, 2020
Although there have been many consultations, announcements, and discussions with various regulatory boards (the ARRC, the FCA), there is still uncertainty around aspects of the LIBOR transition.
By Tom P. Davis, PhD, CFA | October 31, 2018
The London Interbank Offered Rate (LIBOR) has been a mainstay of the financial markets since its inception in the 1980s as an underpinning of the then nascent swap market. Since then, LIBOR has gained fame, and more recently notoriety, and is the reference rate for over $240 trillion in securities globally.
By Tom P. Davis, PhD, CFA | October 31, 2019
In April of 2018, the NY Fed began officially reporting SOFR, and the market started observing its dynamics. SOFR is a volume-weighted median of tri-party repo transactions. Since it is determined by market transactions, the rate is affected by supply and demand, which is driven by daily bank operations and bank intervention. The overnight repo market is especially active at month and quarter-end. This effect, called the “turn”, is well known in money markets.
The valuation of structured products relies on projected prepayments, which in turn rely heavily on the realized path of the mortgage rate. Any stochastic interest rate model must reflect the important empirical behavior that affects the prepayments. A critical behavior of the model is to show high serial correlation of the 10-yr swap rate, which plays a central role in the determination of the mortgage rate.
In this white paper, we explore the LIBOR market model (LMM) and its superiority to a multifactor short rate model when reproducing this serial correlation.
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