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SOFR Term Rates from Treasury Repo Pricing

Wujiang Lou
The Journal of Derivatives Summer 2022, jod.2022.1.153; DOI: https://doi.org/10.3905/jod.2022.1.153
Wujiang Lou
is a director quantitative trader at HSBC, and an adjunct faculty at the New York University in New York City, NY
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Abstract

The Secured Overnight Financing Rate (SOFR) is on a finishing path to replace the US dollar London Inter-Bank Offered Rate (LIBOR). A key issue remains, however: namely, the lack of credit-sensitive term rates equivalent to LIBOR rates. Reaching back to SOFR roots in the Treasury repurchase agreement (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 that the 3-month repo rate is 45 basis points (bps) higher than the same term OIS rate during the Global Financial Crisis, and the bilateral segment is 59 bps higher. The article finds that, contrary to the new risk-free-rates label, SOFR has a credit component, but it is not strong enough for the purpose of replacing LIBOR in the corporate and consumer lending markets. A credit-sensitive benchmark is still needed to fully replace LIBOR.

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The Journal of Derivatives: 29 (5)
The Journal of Derivatives
Vol. 29, Issue 5
Summer 2022
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SOFR Term Rates from Treasury Repo Pricing
Wujiang Lou
The Journal of Derivatives Feb 2022, jod.2022.1.153; DOI: 10.3905/jod.2022.1.153

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SOFR Term Rates from Treasury Repo Pricing
Wujiang Lou
The Journal of Derivatives Feb 2022, jod.2022.1.153; DOI: 10.3905/jod.2022.1.153
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  • Article
    • Abstract
    • TREASURY REPO MARKET AND SOFR
    • TREASURY REPO PRICING SETUP
    • TREASURY REPO TERM SPREAD RESULTS
    • CONCLUDING REMARKS
    • ACKNOWLEDGMENTS
    • ENDNOTES
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