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Since, as far as I understand, an Overnight Index Rate is a set in arrears, i.e. it is published in the morning after the night to which the rate applies, then I would have thought that we should be take into account convexity adjustment when constructing an OIS curve.

However, I have recently come across the following statement:

"The OIS market trades OIS coupons against fixed or Libor coupons. The key point here is that the market prices are for coupon rates, not the daily index rates that are compounded to calculate the coupon rate. So convexity effects due to unnatural payment dates and compounding are already built into the corresponding tenor-specific forward rate curve for this product type."

I am not sure I understand the argument it that statement.

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  • $\begingroup$ On the first point, the convexity adjustment resulting from an overnight rate being paid one day late will be negligible. $\endgroup$ – dm63 Nov 29 '19 at 14:41
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    $\begingroup$ Also there is no convexity adjustment for late fixing, what matters is that the rate be paid on the day it was intended to be paid on. Convexity adjustment occurs only when the payment date is unnatural. In the case of Libor swaps "fixing in arrears" implies "libor start in arrears", and that's what creates the convexity adjustment. $\endgroup$ – Antoine Conze Nov 29 '19 at 14:53

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