SOFR Term Structure Dynamics - Discontinuous Short Rates and Stochastic Volatility Forward Rates

The Secured Overnight Funding Rate (SOFR) has become the risk‐free rate benchmark in US dollars, thus term structure models should reflect key features exhibited by SOFR and forward rates implied by SOFR futures. We construct a multifactor, stochastic volatility term structure model which incorporates these features. Calibrating to options on SOFR futures, we achieve a reasonable fit to the market across maturities and strikes in a single model. This also provides novel insights into SOFR term rate behavior (and implied volatilities) within their accrual periods, and a model mechanism by which interest rate mean reversion arises from monetary policy.

• Publication year

  2024

• Venue

  Social Science Research Network

• Publication date

  2024-03-11

• Fields of study

  Not labeled

• Identifiers
  DOI 10.2139/ssrn.4270811
• External record

  Open on Semantic Scholar

• Source metadata

  Semantic Scholar

• No claims are published for this paper.

• No concepts are published for this paper.

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