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I recently had an interview where I was asked what to use as risk-free rate. In all my textbooks it was always the US treasury yield curve.

But they said no its now the "swap curve".

Why is the swap curve now used as riskfree rate instead of government bonds? This includes to explain the difference between swapcurve and yieldcurve.

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I guess it depends on what they're referring to... The traditional swap curve (LIBOR-based) is certainly not risk free, as evidenced by the experience of the financial crisis and the resulting migration to OIS discounting. The OIS curve (which is a kind of swap curve...) is now the standard risk-free curve.

The Treasury yield curve is not favored, because everyone builds their own smoothed Treasury curves. Depending not the smoothing techniques, the resulting Treasury curves can be pretty different. By contrast, although the curve building methodologies for swap curve can vary, the resulting curves tend to be much more similar.

The Treasury market is also much more technical; e.g., an issue trading special in the repo market can be very expensive, the CTD of a futures can trade rich if the shorts have difficulty finding the issue to make delivery, etc.

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  • $\begingroup$ Can you explain what an OIS curve represents? $\endgroup$ – emcor Jun 10 '15 at 19:21
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    $\begingroup$ Overnight indexed swaps; they're swaps whose floating leg is indexed against an overnight index (e.g., Fed funds effective for USD). $\endgroup$ – Helin Jun 10 '15 at 19:38
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    $\begingroup$ Nice answer, additional comment to OP: The answer of the interviewer is actually imprecise and I would expect from the interviewer to state that the OIS curve is used. There are a gazillion "swap curves" out there. Obviously for your next interviews if such question comes up again you can also ask back what the interviewer means with "swap curve". 2 things can happen: a) Interviewer appreciates your curiosity and (rightly) deems asking for more details important, b) he/she feels challenged in which case you might consider whether you want to work for someone who takes issue with curiosity. $\endgroup$ – Matt Jun 11 '15 at 3:57

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