quick look at the impact of a CFTC recommendation to switch interdealer swaps to SOFR under the recent 'SOFR First' drive
one of the big challenges in this process is the fact that SOFR is an overnight rate and lacks a term structure (1m, 3m, etc)...
cftc.gov/PressRoom/Pres…
some proposed alternatives, such as Bloomberg's BSBY index, attempt to fix this gap by fitting a curve to realized deposit, commercial paper, CD, and bank bond rates to provide term structure while also avoiding the manipulation risk of a Libor survey...
assets.bbhub.io/professional/s…
however regulators have recently come out against such alternatives, claiming they do not eliminate the manipulation risk in the low volume of transactions underlying the index
the officially-endorsed solution is to create Term SOFR rates instead...
sec.gov/news/public-st…
the NY Fed earlier this year selected CME to administer these Term SOFR benchmarks, provided trading volume in CME SOFR futures and linked products reaches desired levels
the Term SOFR rates are to be calculated based on active 1m and 3m SOFR futures...
newyorkfed.org/medialibrary/M…
there are a few technical differences between these two products
the 1m futures price inversely to the arithmetic mean of daily SOFR rates over the contract month
while the 3m futures roll on a quarterly IMM date schedule and price inversely to the compounded rate...
in CME's methodology, the futures data from 3 nearest 3m and 7 nearest 1m contracts is used to calculate implied future SOFR rates over the contract terms
then a step function with breaks at FOMC dates is fitted to model the path of realized SOFR...
cmegroup.com/market-data/fi…
this implied future path of overnight rates is then compounded to calculate a 1m, 3m, and 6m Term SOFR benchmark
this methodology is supported by work from NY FED researchers Heitfield and Park, who wrote a 2019 paper heavily cited by CME...
federalreserve.gov/econres/feds/f…
in this work the researchers found that implied rates from interest rate futures closely tracked the realized forward overnight rates underlying the contracts, which CME uses to justify the value of a Term SOFR benchmark...
that's all for now, thanks for reading if you made it to the end and hope people find some of the linked material informative... cheers! 👍💯
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