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Term rates, multicurve term structures and overnight rate benchmarks: A roll–over risk approach

Backwell, Alex; Macrina, Andrea; Schlögl, Erik; Skovmand, David; (2023) Term rates, multicurve term structures and overnight rate benchmarks: A roll–over risk approach. Frontiers of Mathematical Finance , 2 (3) pp. 340-384. 10.3934/fmf.2023009. Green open access

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Abstract

In the current LIBOR transition to overnight–rate benchmarks, it is important to understand theoretically and empirically what distinguishes actual term rates from overnight benchmarks or "synthetic" term rates based on such benchmarks. The well–known "multi–curve" phenomenon of tenor basis spreads between term structures associated with different payment frequencies provides key information on this distinction. This information can be extracted using a modelling framework based on the concept of "roll–over risk", i.e., the risk a borrower faces of not being able to refinance a loan at (or at a known spread to) a market benchmark rate. Separating the roll–over risk priced by tenor basis spreads into a credit–downgrade and a funding–liquidity component, the theoretical modelling and the empirical evidence show that proper term rates based on the new benchmarks remain elusive and that a multi–curve environment will persist even for rates secured by repurchase agreements.

Type: Article
Title: Term rates, multicurve term structures and overnight rate benchmarks: A roll–over risk approach
Open access status: An open access version is available from UCL Discovery
DOI: 10.3934/fmf.2023009
Publisher version: https://doi.org/10.3934/fmf.2023009
Language: English
Additional information: This is an Open Access article published under a Creative Commons Attribution 4.0 International (CC BY 4.0) Licence (https://creativecommons.org/licenses/by/4.0/).
Keywords: Roll–over risk, multi–curve interest rate term structure, risk–free rates, OIS, IBOR, LIBOR transition, interest rate benchmark reform, basis swaps, affine term structure models, calibration and estimation
UCL classification: UCL
UCL > Provost and Vice Provost Offices > UCL BEAMS
UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Maths and Physical Sciences
UCL > Provost and Vice Provost Offices > UCL BEAMS > Faculty of Maths and Physical Sciences > Dept of Mathematics
URI: https://discovery.ucl.ac.uk/id/eprint/10166146
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