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bakait
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Joined: January 11th, 2010, 4:34 am

LIBOR OIS spread

October 14th, 2010, 12:14 pm

Hi All,OIS rate is quoted by the Fed and LIBOR is inter bank rate, which is greater than OIS rate. The difference between LIBOR and OIS accounts for Credit risk which one bank has while lending to another bank. Now I am having following questions on this.1) Whenever pricing some security, why do we choose LIBOR rate as risk free rate (involving credit risk). why not OIS rate which seems to be risk free rate?2)Does OIS rate come into play only whenever one bank/individual is doing some kind of deal/transaction with Govt authority (risk free authority). I know that OIS is traded on exchange and we can assume exchange to be risk free. Does OIS also trade in OTC markets?Regards
 
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Martinghoul
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Joined: July 18th, 2006, 5:49 am

LIBOR OIS spread

October 14th, 2010, 1:52 pm

1) We don't choose LIBOR. In fact, the mkt increasingly is gravitating towards the OIS rate. Moreover, be aware that just because the O/N rate (FF effective) is published by the Fed, that doesn't mean it's risk-free. It's still lending O/N unsecured.2) There is a mkt for O/N cash. It's not really traded on an exchange, but that doesn't matter. Derivatives based on OIS rates, such as OIS swaps, are traded in the OTC mkt actively.