whitepaper
The Impact of Liquidity Transfer Pricing on SOFR Interest Rate Cap and Floor Implied Volatility
July 6, 2021

Interest rate caps and floors are important financial derivatives for managing interest rate risk. As alternative rates like SOFR are promoted as replacement benchmarks for USD Libor, there is growing interest in caps and floors with alternative rates as underlying. But challenges related to pricing and risk management of  these derivatives are clear, due to the lack of liquidity and available market data. 

Topics Covered:

• Pricing theory for SOFR in-arrears caps based on continuous hedging with interest rate futures
• SOFR caplet vol surface construction
• The important role of market-driven liquidity in  pricing today’s SOFR cap/floor options
 

The Impact of Liquidity Transfer Pricing on SOFR Interest Rate Cap and Floor Implied Volatility
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