2
$\begingroup$

I'm a little embarrassed about this because I have a PhD in math, but I'm having a little trouble working out how to bootstrap an OIS curve from libor rates and basis swap rates. If I had an equation for valuing everything I'd be set. What I have is a libor curve and a mysterious rate (US dollar OIS) coming from Bloomberg that is somehow related to basis swaps. I have been told that the basis swaps are between Libor and OIS, and I don't know what the equation for that looks like.

For some background, I just learned how to value a swap today, and from that I was able to figure out how to bootstrap the libor curve. I just need an equation to fit the numbers into. I've gotten loads of verbal explanations, so no need to go out of your way to provide one. Thanks.

Improve this question
$\endgroup$
5
  • 4
    $\begingroup$ Have you checked out the following paper? papers.ssrn.com/sol3/papers.cfm?abstract_id=2219548 $\endgroup$
    – Olorun
    Jul 23, 2015 at 12:31
  • $\begingroup$ @Olorun thanks, this looks like it'll be helpful. $\endgroup$
    – Math
    Jul 23, 2015 at 13:03
  • $\begingroup$ @Olorun this is exactly what I needed, thanks! Had to sift through the notation but I figured out what the number means and what to do with it. $\endgroup$
    – Math
    Jul 23, 2015 at 13:54
  • $\begingroup$ The paper @Olorun mentioned looks quite interesting. Keep in mind that for your stated problem you need to derive OIS rates, hence you need to build an OIS curve. A traditional libor curve is of very little help here. Most practitioners nowadays build OIS curves rather than libor curves. So for your situation you need OIS rates as input and need to build an OIS curve. Libor curves are irrelevant in this context. $\endgroup$
    – Matt Wolf
    Jul 24, 2015 at 4:54
  • 1
    $\begingroup$ @MattWolf I have swap and basis swap rates as input (and eurodollar futures) and need to construct both a libor and an OIS curve. Quoted OIS rates are not available. $\endgroup$
    – Math
    Jul 24, 2015 at 11:13

1 Answer 1

Reset to default
5
$\begingroup$

An OIS, or Overnight Index Swap, is an interest rate swap whose floating leg payments are calculated as a geometric average of the daily fixings of some underlying O/N or T/N index (these indices are generally volume-weighted averages of reported daily transactions). The annualized floating leg rate is defined as $$ c_T^{float} = \frac{\prod^{s+T}_{t=s}{(1+r_t\delta (t))}-1}{\delta (T-s)}, $$ where $s$ is the first fixing day of the coupon period and $T$ is the last. $r$ is the value of the underlying index at time $t$, and $\delta (\cdot)$ is the year fraction according to an appropriate day count convention.

A basis swap is an exchange of one floating rate for another. In this case, it refers to the exchange of USD Libor for USD OIS or vice versa. Generally, if we refer to the two bases in a basis swap as $\alpha$ and $\beta$ and you are fixed payer in the swap with basis $\alpha$, your basis swap rate (or fixed rate spread) is $$ r_{basis swap} = c^{fixed}_\beta-c^{fixed}_\alpha, $$ where $c_b^{fixed}$ is the fixed coupon rate for a interest rate swap with basis $b$. From here on out, you may derive your implied OIS rates from the two rates and bootstrap as normal.

Improve this answer
$\endgroup$
2
  • $\begingroup$ Could you elaborate a bit on how to derive OIS rates from IRS rates and ois/libor basis spread? For example 7Y IRS rate is 2% and 7Y basis swap spread is 22.2bps. How do I derive 7Y OIS rate? I assume it is more complex than simply subtracting basis spread from IRS rate, correct? $\endgroup$
    – andr111
    Aug 14, 2015 at 19:11
  • $\begingroup$ in your first formula is each time period expected to be 1 day (thus you compound for weekends) or periods between reset days (in which case daycount is sometimes 3 days). Difference between (1+rd)^n and (1+rdn) where n is a number that is not 1 and d is the year-fraction for a single day (often 1/360). Using log1p it would be the difference between adding n(log1p(rd)) and log1p(rdn). $\endgroup$
    – CashCow
    Oct 4, 2019 at 14:01

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge that you have read and understand our privacy policy and code of conduct.

Not the answer you're looking for? Browse other questions tagged or ask your own question.