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Technical Paper: SOFR and €STR Discounting: Forward Convexity from Discount-Rate Transition

Featured on SSRN, Authored by Jonathan Rosen, PhD

The financial industry is hard at work preparing for the cessation of the Libor benchmark interest rate, which may happen as soon as January 2022. Concurrently, there is an initiative to encourage the increase of trading volume and activity linked to alternative reference rates (ARRs), such as SOFR and €STR, so that they are widely adopted and can successfully replace Libor.

However, challenges still exist, as the transition to the new ARR’s will also mean changes to how discounting is handled. In this technical paper, Jonathan Rosen, PhD, discusses:

  • The challenges around discounting for SOFR and €STR
  • A new “hybrid” risk-neutral measure that may solve these challenges
  • Technical representation/ formulas on using the hybrid measure
  • The impact of the hybrid measure on forward curve construction 

Read this technical paper to learn more.