Short Rate Modelling: A Data Driven Approach

Gellert, Karol Tomasz

Short Rate Modelling: A Data Driven Approach

Gellert, Karol Tomasz

Permalink

Publication Type:: Thesis
Issue Date:: 2023

Open Access

Copyright Clearance Process

Recently Added
In Progress
Open Access

This item is open access.

Adobe PDF

Download thesisAdobe PDF (2.94 MB)

View statistics

Full metadata record

Field	Value	Language
dc.contributor.author	Gellert, Karol Tomasz
dc.date.accessioned	2024-05-30T04:19:34Z
dc.date.available	2024-05-30T04:19:34Z
dc.date.issued	2023
dc.identifier.uri	http://hdl.handle.net/10453/179341
dc.description	University of Technology Sydney. Faculty of Business.	en_US.UTF-8
dc.description.abstract	The Secured Overnight Funding Rate (SOFR) has become the main Risk–Free Rate benchmark in US dollars, thus interest rate term structure models need to be updated to reflect the key features exhibited by the dynamics of SOFR and the forward rates implied by SOFR futures. Historically, interest rate term structure modelling has been based on rates of substantially longer time to maturity than overnight, but with SOFR the overnight rate now is the primary market observable. This means that the empirical idiosyncrasies of the overnight rate cannot be ignored when constructing interest rate models in a SOFR–based world. As a rate reflecting transactions in the Treasury overnight repurchase market, the dynamics of SOFR are closely linked to the dynamics of the Effective Federal Funds Rate (EFFR), which is the interest rate most directly impacted by US monetary policy target rate decisions. Therefore, these rates feature jumps at known times (Federal Open Market Committee meeting dates), and market expectations of these jumps are reflected in prices for futures written on these rates. On the other hand, forward rates implied by Fed Funds and SOFR futures continue to evolve diffusively. We find that incorporating these empirical features into an interest rate term structure model are key to accurately fitting short-term instruments, in particular futures on one–month compounded SOFR. Informed by this, we construct a tractable multifactor, stochastic volatility term structure model which incorporates these features. Calibrating to prices for options on SOFR futures, we achieve a reasonable fit to the market across available maturities and strikes in a single, consistent model. The model also provides novel insights into SOFR term rate behaviour (and implied volatilities) within the SOFR term rate accrual periods, as well as a credible model mechanism by which interest rate mean reversion arises from monetary policy.	en_US.UTF-8
dc.format	Thesis (PhD)
dc.language.iso	en_US	en_US.UTF-8
dc.relation	https://opus.lib.uts.edu.au/bitstream/10453/179341/1/thesis.pdf
dc.rights	info:eu-repo/semantics/openAccess
dc.rights	The author owns the copyright in this thesis including all reproduction and reuse rights for the work. The work may not be altered without the permission of the copyright owner. Attribution is essential when quoting or paraphrasing from this thesis.
dc.rights	© 2023 Karol Tomasz Gellert
dc.rights	au.edu.uts.lib/cph
dc.title	Short Rate Modelling: A Data Driven Approach	en_US.UTF-8
dc.type	Thesis
utslib.copyright.status	open_access	*

Abstract:

The Secured Overnight Funding Rate (SOFR) has become the main Risk–Free Rate benchmark in US dollars, thus interest rate term structure models need to be updated to reflect the key features exhibited by the dynamics of SOFR and the forward rates implied by SOFR futures. Historically, interest rate term structure modelling has been based on rates of substantially longer time to maturity than overnight, but with SOFR the overnight rate now is the primary market observable. This means that the empirical idiosyncrasies of the overnight rate cannot be ignored when constructing interest rate models in a SOFR–based world. As a rate reflecting transactions in the Treasury overnight repurchase market, the dynamics of SOFR are closely linked to the dynamics of the Effective Federal Funds Rate (EFFR), which is the interest rate most directly impacted by US monetary policy target rate decisions. Therefore, these rates feature jumps at known times (Federal Open Market Committee meeting dates), and market expectations of these jumps are reflected in prices for futures written on these rates. On the other hand, forward rates implied by Fed Funds and SOFR futures continue to evolve diffusively. We find that incorporating these empirical features into an interest rate term structure model are key to accurately fitting short-term instruments, in particular futures on one–month compounded SOFR. Informed by this, we construct a tractable multifactor, stochastic volatility term structure model which incorporates these features. Calibrating to prices for options on SOFR futures, we achieve a reasonable fit to the market across available maturities and strikes in a single, consistent model. The model also provides novel insights into SOFR term rate behaviour (and implied volatilities) within the SOFR term rate accrual periods, as well as a credible model mechanism by which interest rate mean reversion arises from monetary policy.

Please use this identifier to cite or link to this item:

http://hdl.handle.net/10453/179341