Tuesday, 23 May 2023

US -- Eurodollar futures a USD 8 million rounding error

Last week, Marc presented a workshop on the ”LIBOR transition: What could we have done better from a quantitative perspective?” at the CEETA Benchmark Congress in Warsaw.

Among the elements presented were the results of the fallback on euro-dollar futures at CME that were converted to SOFR futures. An interesting issue with the conversion is the number of decimals. The conversion was done using the ISDA/Bloomberg designed spread between USD-LIBOR-3M and the replacement SOFR of 26.161 bps. This is a number in basis points with three decimals. But the futures are quoted with only 0.5 basis point precision. A natural question is what happen to the extrta decimals? Simply it created a profit for those who understood it.

In the conversion, roughly 4 millions LIBOR futures were converted to SOFR futures, but the open interests in SOFR futures were almost unchanged. The 4 millions futures did not simply disappear, there were offsetting positions between the LIBOR and SOFR futures that had cancelling effects on the next day. The offsets were not between different market participants, but for the same participant having offsetting positions between LIBOR and SOFR futures. The spread between the two was known since 5 March 2021. The amount involved is 4,000,000 contracts with USD 1,000,000 notional each, this means USD 4,000,000,000,000 (4 trillions), not a notional resulting from an ignorant retail trader!

The closing price for the different futures on 14 April 2023 (the conversion date) were:

Closing prices Sep 23 Dec 23 Mar 24
ED 94.965 95.33 95.785
SR3 95.225 95.59 96.045
Spread (bps) 26 26 26

Take the strategy to buy SR3 at 95.225 and Sell ED at 94.965. The next day, the position is Long SR3 at 95.225 and Short SR3 at 95.22626. The total P/L is, irrespective of the price the next day: (P - 95.225) - (P - 95.22661) = 0.00161%.

The impact of rounding is (number of contracts x notional / basis points / quarterly / offsets * spread)

4,000,000 x 1,000,000 / 10,000 / 4 / 2 * 0.161 ~ 8,000,000

The rounding had an impact of USD 8,000,000.

Given that the spread is known since March 2021, one can guess that market makers have used any opportunity in the last 2 years to add ofsseting positions each time the tradable spread moved away from the 26.161 basis point. The actual arbitrage from the conversion is probbaly well above the figure indicated above.

Hopefully our readers were on the profitable side of the arbitrage.

Don't hesitate to contact us if you require advisory services related to the benchmark transitions.

Publication: LIBOR: le chiffre le plus important du monde disparaît

Marc a publié un article de vulgarisation sur la disparition du LIBOR dans le magazine EcoFin Mag (ECOFINMAR n 15 - mars 2023, page 32). L’article est intitulé

LIBOR: le chiffre le plus important du monde disparaît.

Une copie de l’article peut être obtenue ici.

Sunday, 7 May 2023

Swap Rates and Term Structure Modelling: Implementation note published

The implementation note related to the Swap Rates and Term Structure Modelling described in one of our previous post has now been published on SSRN.

The note is available as a muRisQ Advisory Implementation Notes:

Swap Rates and Term Structure Modelling

The paper is available on SSRN



WThis document contains implementation notes related to Bang and Daboussi (2022). We have extended the original paper by allowing actual accrual factors (not all 1) and non-annual frequency on the fixed side. The note first describes the detailed formulas in this extended setting. In a second part some choices of the implementation and results obtained are provided.

Don't hesitate to contact us if you require advisory services related to interest rate modelling.