LIBOR Transition Learning Goals – Topics in Focus
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Quantitative Analyst
Learning Objectives
- Understand new market conventions for SOFR, SONIA, ESTR, HONIA and SARON – Compounding/Averaging, Lookbacks, Lockouts, Observation Period Shift, Payment Gaps.
- Review of Collateralized Pricing Assumptions and Multi-Curve building with OIS.
- Define detailed curve configurations and instrument recommendations – Flat forwards between FOMC meetings, Hermite interpolation, Overlapping 1M and 3M futures.
- Incorporating most recent developments – CMS fallback definitions, cap/floor with SOFR term rates and reset in advance.
- Market liquidity and volumes of derivatives and cash instruments.
- Deriving volatilities for SOFR options based on implied LIBOR volatilities and skew for normal, shifted lognormal and SABR model.
- Quantifying economics and structural differences between LIBOR term rates and RFRs.
- Define and use algorithms to compute adjustment spreads for ISDA fallbacks and Cash Instrument fallback waterfalls.
- Adjustments to existing models including futures convexity adjustments, average swaps, shifted log-normal and Libor Market Model.
- Quantifying P&L Impact on Fallback Date and Its Implications for Derivatives, Fixed Income, Loans and Structured trades such as CLOs.
Course Framework
1. P&L Impact on Fallback Date and Its Implications
- Significance of value transfer for existing Libor contracts
- Impact on counterparty exposure, collateral and xVA measures
- Impact of tax treatment on the decision- making process for transition timing
- Limits and risk mitigation on potential fallback P&L impact
- Exposure measures and hedging of LIBOR SOFR basis spread
2. LIBOR Market Model Introduction and FMM
- Difference of Transition Impact on Hull&White and LMM
- Review of LMM and it’s Underlying Behavior
- Issues with LMM and Reset in Arrears Backward Looking Rates
- Model Changes based on Lyashenko and Mercurio
- Deterministic Volatility Decay Function and Ease of Implementation
3. Impact on Existing Model Libraries
- Fixed Income models and methodologies
- Derivatives models and methodologies
- Modifying and adjusting for RFR replacement differences
- Managing model risk management workflow
4. Comprehensive Components of Model Documentations
- Fixed Income models and methodologies
- Derivatives models and methodologies
- Modifying and adjusting for RFR replacement differences
- Managing model risk management workflow
5. Regulatory Guidance on Model Risk Management
- US – FED’s SR 11-7: Guidance on Model Risk Management
- Basel and EU Guidelines
- Applicability to LIBOR Transition
6. Principles of Quantitative Model Validation and Model Risk Management
- Definitions of Model, Model Risk and Input/Output/Engine components
- Model Uses across the Enterprise using Practical and Closed Form Calculations
- Required Processes for Model Validation for Fundamental Changes or Rates
- Apply Quant Culture with IT Discipline to Manage Transition
7. New Model Risk Contributing Factors
- Econometric Model Changes for the the new Risk-Free Rates
- Backward and Forward Looking Term Rates and Shift of Effective Dates and Accrual Dates
- FAS133 Hedge Effectiveness Testing Changes for new Benchmarks and Transition
- Statistical Behavior of the new Rates and Credit Components
- Model Risk Contributing Factors and Changes in Market Regime
- New or Untested Model Type or Class
8. Model Users and their Expectations
- Behavior and Expectations of Traders and Business Decision Makers
- Risk Management across Enterprise and Desk level
- Financial Controls and Accounting
- Regulators and Policymakers and Expectations on Transition
9. Vanilla/Static, Dynamic and Credit Models
- Term Structure Models for Interest Rates
- Market-Implied PD and LGD Models
- Actuarial-Statistical PD, Risk Migration and Loss Models
- Stochastic Models for Equity,FX and Commodity
10. LIBOR Usage and Major Components of Required Model Changes
- Compounding, Averaging and Daily Observation Impact
- Curve and Collateral Dependency Revision across all Currencies
- Move from HJM/LMM to FMM Model
- Convex Accrual Function across all Asset Classes
- Funding and Loan Index Recommendations to Account for Credit Component of LIBOR
- Timeseries Considerations and Historical SOFR model to have data back to 1998
11. Dynamic Mortgage Models with Current Coupon, Prepayment and Credit
- Stochastic Interest Rate Models and CMS Rates as Inputs
- Current Coupon Model and lack of SOFR History
- Prepayment, Default, Loss Severity Models
- Structured Securities and Collateral LIBOR assumptions
12. Hands-on New Payment and Accrual Conventions for FRN and Swaps for Reconciliations
- Differences among 1M SOFR, 3M SOFR, Eurodollar and Fed Fund future
- Reasons for calculation differences
- Differences of payment and accrual conventions among fixed income, lending and derivatives
- Listing of reliable rate calculation engines for reconciliation of payments
- Detailed examples of payment gap, lockout, observation shift and observation period shift
- Reset in Advance SOFR option products
13. Build the Short End of the RFR Curve and Cross-Currency Basis
- Instruments to define LIBOR, RFR, OIS curves and their relationships
- Interest rate parity for FX forwards and if RFR will have an impact on FX projections
- Impact of RFR on the cross-currency basis in the short end of the curve
- Implementation of the short end of the curve and implied likelihood of Fed Fund rate
- changes
- Multiple different overlapping futures contracts in a single curve
- SOFR term rate and futures
14. Build the Long End of the RFR Curve and Cross-Currency Basis
- Many alternatives to build the long end of the curve
- Removal of LIBOR dependency on the SOFR curve
- Long end discussion with SOFR outright vs basis to OIS or LIBOR
- Necessity for multi-curve bootstrapping when SOFR swap discounts on SOFR
15. Deriving Volatilities for A Proxy Index
- Generalized dynamic model of Mercurio
- Deriving SOFR volatilities from LIBOR volatilities
- Numerical examples of shifted lognormal
- Numerical examples of SABR replication
16. Impact of small SOFR convention discrepancies to discount factors
- Curve dependency examples and how it affects errors in zero rates
- Pricing examples for swaps and it’s curves and reconciliation impact
- Payment and accrual convention impact on zero rates
- Pricing examples for swaps and it’s curves and reconciliation impact
17. Smooth Interpolation with Various Interpolation Techniques
- Desirable features of any interpolation techniques
- Quite comprehensive view of interpolation techniques
- Different interpolation methodologies on zero, forward rates and discounting factors
- Can linear methods have continuity in forward rates?
- Spline methods and mentioning of Hermite interpolation as well as Hagan’s monotone convex method
18. Pitfalls of Flat Daily One Day Forward Rates and FOMC Meeting Dates
- Implied jumps in forwards due to FOMC meeting and future expiration dates
- Curve generation algorithm in detail combining overlapping futures
- Can you build a good forward rate curve with bootstrapping or do you need an optimization across instruments
- Large spikes in forwards close to FOMC meeting dates
