LIBOR and SOFR: Dilemmas and Solutions

Abstract

This paper examines the flaws of the London Interbank Offered Rate (LIBOR) and its replacement, the Secured Overnight Financing Rate (SOFR). As a key benchmark in global finance, LIBOR faced a crisis of confidence due to manipulation and inaccuracy, particularly during the 2008 financial crisis. Its subjective determination process, based on bank estimates rather than actual transactions, made it vulnerable to exploitation, as evidenced by the 2012 LIBOR scandal. The article explores LIBOR’s role in the Eurodollar market, highlighting how its pricing mechanism allowed for manipulation. In response, SOFR was adopted in 2022 as a more transparent and transaction-based alternative. However, SOFR presents challenges, including higher volatility and a lack of term structure. Despite transition difficulties and market inertia, SOFR is emerging as the dominant benchmark for USD-denominated assets, signaling an irreversible shift in financial markets.