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Can someone provide me an intuitive explanation of how discount factors are bootstrapped for SOFR when Swaps are trading with payment delay/ lag (e.g. of 2 business days).

I can intuitively derive the discount factors when the payment lag is zero e.g.

Trade Date Value Date Tenor Maturity Swap Rate Pay Lag
1 Feb 2023 3 Feb 2023 (T+2) 1M 3 Mar 2023 3.5% 0

Since Payment Lag = 0, the cash flow date is 3 Mar 2023.

Now the discount factor from 3-Feb-2023 to 3-Mar-2023 equals 1/(1+3.5%*28/360) ==> 0.99728516

This would then get multiplied with the discount factor for 3 Feb 2023 to arrive at the final discount factor from 1-Feb-2023 to 3-Mar-2023.

However, when the payment lag is 2 days, then the Cash Flow Date is 7 Mar 2023, although accrual period remains the same (3 Feb 2023 to 3 Mar 2023). How would the discount factors get calculated, in this scenario ?

Appreciate any clarity from your side. I hope the question is clear.

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The convexity adjustments for payment lags are usually so tiny (see Why is there a convexity adjustment if the payment date differs from Libor end date?) that we can ignore them for the bootstrapping. So you only need to worry about the accrual periods etc

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