2
$\begingroup$

Will replacing the 3-month tenor of the US LIBOR with SOFR or CME 3-Month SOFR Futures work as well as an indicator of credit risk?

I have my doubts given:

  1. SOFR reflects secured lending
  2. LIBOR is forward looking
  3. LIBOR incorporates term liquidity and credit premia
$\endgroup$

3 Answers 3

3
$\begingroup$

I think it's a good question. But just remember a few nuances:

  1. They both do have futures, so you can get exposure to future rates. For example, you can trade June Eurodollars now as well as June SOFR futures.
  2. They both do have credit risk. Just less with SOFR since it is collateralized.
  3. Another nuance. Sometimes there are collateral scarcities or over-saturation of collateral. That will give SOFR some characteristics that are not present in LIBOR.

But your fundamental point is right - SOFR is a bad replacement for LIBOR.

$\endgroup$
3
$\begingroup$

You are correct. SOFR is an overnight, secured lending rate. It does not have an unsecured credit risk element , and it does not have a term premium. As a result, it is expected to behave differently to 3month libor in a credit crisis. However it has advantages: it is based on a large volume of transactions and is therefore much harder to manipulate than Libor, for example.

$\endgroup$
2
$\begingroup$

There is a number of companies who seek to develop and offer a credit sensitive benchmark.

Why this is needed (or there is a desire for such indices) becomes clear when looking at March 2020. Flight to quality and FED liquidity pushed SOFR down, but credit concerns in banking pushed up 3m Libor.

Edit BSBY will be discontinued on November 15,2024 after a damning Iosco verdict, see Risk.net.

$\endgroup$
0

Your Answer

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

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