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Dynamic term structure models for SOFR futures
Author(s) -
Skov Jacob Bjerre,
Skovmand David
Publication year - 2021
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.22246
Subject(s) - futures contract , term (time) , economics , affine term structure model , market liquidity , heath–jarrow–morton framework , volatility (finance) , econometrics , financial economics , arbitrage , forward rate , convexity , derivative (finance) , yield curve , monetary economics , interest rate , physics , quantum mechanics
The London InterBank Offered Rate is scheduled for discontinuation, and the replacement advocated by US regulators is the Secured Overnight Financing Rate (SOFR). The only SOFR‐linked derivative with significant liquidity and trading history is the SOFR futures contract, traded at the Chicago Mercantile Exchange. We use the historical record of futures prices to construct dynamic arbitrage‐free models for the SOFR term structure. We find that a Gaussian arbitrage‐free Nelson–Siegel model describes term structure well without accounting for jumps and seasonal effects observed in SOFR. However, a shadow‐rate extension is needed to describe volatility near the zero‐boundary impacting the futures convexity adjustment and option pricing.