LIBOR vs. OIS: The Derivatives Discounting Dilemma

by John Hull of University of Toronto, and
Alan White of University of Toronto

March 2013

Abstract: Traditionally practitioners have used LIBOR and LIBOR-swap rates as proxies for risk-free rates when valuing derivatives. This practice has been called into question by the credit crisis that started in 2007. Many banks now consider that overnight indexed swap (OIS) rates should be used for discounting when collateralized portfolios are valued and that LIBOR should be used for discounting when portfolios are not collateralized. This paper examines this practice and concludes that OIS rates should be used for discounting in all situations.

JEL Classification: G21,G33.

AMS Classification: 91G40,91B28.

Keywords: LIBOR, OIS, Derivatives, Discounting.

Forthcoming in: Journal of Investment Management

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