RT Journal Article
SR Electronic
T1 SOFR Term Rates from Treasury Repo Pricing
JF The Journal of Derivatives
FD Institutional Investor Journals
SP jod.2022.1.153
DO 10.3905/jod.2022.1.153
A1 Wujiang Lou
YR 2021
UL https://pm-research.com/content/early/2022/02/15/jod.2022.1.153.abstract
AB 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.