The "Libor Term Premium"

Here's a Blast From The Past (no, not the Ringo Starr compilation album) that is a talking point again now the market is going to be replacing LIBOR with a new reference, which will differ for USD, GBP and EUR. In GBP the replacement SONIA rate (hopefully quoted as a 3M and 6M SONIA fixing, although that's to be confirmed) may incorporate a credit premium at outset, reflecting that Libor always had one and Sonia doesn't. And what is the Libor-Sonia differential? At present it's about 12 bps, but of course it fluctuates. But in fact understanding the original overnight-3M Libor Term Premium was worthwhile even pre-crash...here we re-present Chapter 10 from Professor Choudhry's book "Bank Asset-Liability Management", published in April 2007, which talks about just that. A Golden Oldie to remind us that we should be thinking seriously about the ALM impact of, and management actions required by, the SONIA replacement reference rate.

by Professor Moorad Choudhry