Turn-of-Year Effects in Curve Building

Banks report their balance sheets to regulators as of a single snapshot date, most commonly December 31st. To make their reported leverage and capital ratios look better on that specific day, many banks temporarily pull back from short-term lending right around year-end, which drains the supply of overnight and short-dated cash. That temporary scarcity pushes borrowing rates that span December 31st sharply higher for just a few days, the turn-of-year effect.

Why curve builders single it out

If a curve-building algorithm treats every short-dated instrument as equally smooth, a single elevated overnight rate that spans December 31st can bleed into forward rates for unrelated periods nearby, making valuations wrong for trades that have nothing to do with year-end funding. Practitioners instead add an explicit "turn" adjustment: a separate, short-lived bump in the forward curve that captures the year-end spike and nothing else, leaving the rest of the curve smooth.

A desk pricing an overnight index swap or a repo trade that happens to span December 31st needs this adjustment priced in explicitly, since ignoring the turn would misprice exactly the days when funding is most expensive.