Turn-of-Year Effects in Curve Building
Short-term interest rates often spike right around New Year's Eve because banks temporarily shrink their balance sheets for regulatory reporting, and a curve builder has to handle that spike separately or risk distorting nearby forward rates.
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.
Turn-of-year effects are a short-lived rate spike caused by banks shrinking balance sheets for year-end regulatory snapshots, and a curve builder must model that spike as its own separate node rather than smoothing it into neighboring rates.
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.
Practice in interviews
Further reading
- Practitioner note: money-market desks and year-end funding