LIBOR Versus OIS: The Derivatives Discounting Dilemma

John Hull and Alan White

Volume 11, Number 3, Third Quarter 2013

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 as the risk-free rate when collateralized portfolios are valued and that LIBOR should be used for this purpose when portfolios are not collateralized. This paper examines this practice and concludes that OIS rates should be used in all situations.