SOFR Bootstrapping Modeling Methodologies and Issues (w/ Python and Excel Replicas of Bloomberg SOFR @ GitHub)

Abstract

Following the 2008 financial crisis, interest rate market experienced major changes in the ways Libor rate was treated. Since Libor is not a risk free rate, the dual curve bootstrapping (Libor-OIS) has been introduced. The term risk premium (e.g., 3m6m Libor basis) has been handled via newly introduced multi-curve framework. The discovery of the Libor rate manipulations back in 2007 broke Libor's back. Citigroup introduced Nybor in 2008 as an alternative to Libor. Following the Libor crisis, the Alternative Reference Rates Committee (ARRC) has been established to ensure a successful transition from U.S. dollar (USD) Libor to a more robust reference rate, its recommended alternative, the Secured Overnight Financing Rate (SOFR). This rippled through other countries with introductions of SONIA (for GBP Libor), ESTER (for Euribor), etc. Although there are a lot of modeling similarities between Libor and SOFR rate bootstrapping, there are a number of differences. In this paper we discuss bootstrapping methodologies along with some modeling differences and new modeling considerations.