Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/257978 
Year of Publication: 
2020
Citation: 
[Journal:] Risks [ISSN:] 2227-9091 [Volume:] 8 [Issue:] 1 [Article No.:] 23 [Publisher:] MDPI [Place:] Basel [Year:] 2020 [Pages:] 1-18
Publisher: 
MDPI, Basel
Abstract: 
Interest rate benchmarks are currently undergoing a major transition. The LIBOR benchmark is planned to be discontinued by the end of 2021 and superseded by what ISDA calls an adjusted risk-free rate (RFR). ISDA has recently announced that the LIBOR replacement will most likely be constructed from a compounded running average of RFR overnight rates over a period matching the LIBOR tenor. This new backward-looking benchmark is markedly different when compared with LIBOR. It is measurable only at the end of the term in contrast to the forward-looking LIBOR, which is measurable at the start of the term. The RFR provides a simplification because the cash flows and the discount factors may be derived from the same discounting curve, thus avoiding-on a superficial level-any multi-curve complications. We develop a new class of savings account models and derive a novel interest rate system specifically designed to facilitate a high degree of tractability for the pricing of RFR-based fixed-income instruments. The rational form of the savings account models under the risk-neutral measure enables the pricing in closed form of caplets, swaptions and futures written on the backward-looking interest rate benchmark.
Subjects: 
caplets
futures
LIBOR
LIBOR transition
rational term structure models
risk-free rates
SOFR
SONIA
swaptions
Persistent Identifier of the first edition: 
Creative Commons License: 
cc-by Logo
Document Type: 
Article
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