Interest Rate Swap Spreads Research Articles

Examining the impact of central clearing and swap execution facilities on interest rate swap spreads and their determinants

This study explores how the determinants of interest rate swap spreads have changed since the implementation of Title VII of the Dodd-Frank Act of 2010. Utilizing ordinary least squares (OLS) regression, we analyze key variable effects at different stages of the regulation. Through this approach, we offer valuable insights into the impact of central clearing and trading on swap execution facilities (SEFs) and swap spreads. First, contrary to previous empirical evidence, increases in swap volatility correspond to a tightening, rather than a widening, of swap spreads after the implementation of SEF trading. This result suggests the SEF framework may enhance the appeal of swaps as a safe-haven and hedging instrument. Second, we observe that the Treasury liquidity premium (TLP) no longer significantly influences swap spreads after the implementation of SEF trading. Third, after SEF trading occurs, the curve slope and swap volatility remain the only significant drivers of swap spreads. Last, a difference-in-difference analysis reveals that the regulation did not materially impact changes in swap spreads; instead, they align with the observed trend of spread tightening in the overall markets. These results signify significant departures from previous research findings (Grinblatt, 2001; Fehle, 2003; Tah, 2022), holding importance for academic scholars and practitioners in swap pricing and risk management.

Determinants of Interest rate swap spreads: A quantile regression approach

Determinants of Interest rate swap spreads: A quantile regression approach

Yield curve reactions to fiscal sentiment in Brazil

PurposeUsing a fiscal sentiment indicator, this study aims to verify whether fiscal sentiment affects the yield curve in Brazil. Since policymakers highlight the coordination between monetary and fiscal policies and the importance of fiscal policy to the expectations formation process in inflation targeting regimes, the authors also explore the transmission mechanism through inflation expectations. Hence, the study also analyzes the effect of fiscal sentiment on interest rate swap spreads through the inflation expectations channel.Design/methodology/approachBased on information obtained from official communiqués about fiscal policies issued by the Central Bank of Brazil and the Brazilian Ministry of Finance, the study builds a fiscal sentiment indicator. The econometric strategy to verify whether fiscal sentiment is related to the short tail of the yield curve is based on time series analysis through ordinary least squares and generalized method of moments estimates. In turn, to estimate the transmission mechanism through inflation expectations, the model uses interaction terms between fiscal sentiment and inflation expectations.FindingsThe results suggest a more optimistic (pessimistic) fiscal sentiment reduces (increases) swap spreads. The findings reveal that improvements in fiscal credibility and a more optimistic fiscal sentiment are able to reduce the positive marginal effect that inflation expectations variations have on interest rate swap spreads.Originality/valueThis study contributes to the literature, as, to the best of authors’ knowledge, it is the first to analyze the content of the communiqués related to fiscal policy, and based on this content, it extracts the sentiment related to the fiscal environment and analyzes the effect of this sentiment on the yield curve. Besides, different from existing studies that analyze the effect of fiscal backward-looking aspects (such as public debt, budget balance, taxes and public spending) on the yield curve, this study investigates forward-looking aspects related to fiscal policy (such as fiscal credibility and fiscal sentiment).

Ripple Effects, the Long-Run Relationship, and Dynamic Corrections among Interest Rate Swap Spreads

Ripple Effects, the Long-Run Relationship, and Dynamic Corrections among Interest Rate Swap Spreads

Ripple Effects, the Long-Run Relationship, and Dynamic Corrections among Interest Rate Swap Spreads

This study tests the ripple effects, long-run convergence, and dynamic correlation structures of swap spreads of varying maturities. The study employs the ARDL bounds-testing approach and the asymmetric DCC methodology on daily data spanning 15 years. The results largely support the presence of the ripple effect and the long-run convergence of swap spreads of differing maturities. However, there are significant variations in the strength and speed of adjustment towards long-run equilibrium relationship among diverse maturities. Most pairs of swap spreads exhibit strong, symmetric, highly persistent, and time-varying dynamic co-movements, suggesting interdependence and information flow among the swap spreads of varied maturities.

What determines the yen swap spread?

We investigate if Japanese yen denominated interest rate swap spreads price risks in addition to liquidity and default risk. These additional risks include: the time-varying correlation between interest rates of different types and maturities; business cycle risk; and market skewness risk. Our analysis, over a number of different maturities and sample periods, supports the existence of an additional risk premium. We also show that the time-varying correlation between short term market interest rates (e.g., TIBOR) and the longer term Government bond yield (e.g., Gensaki) is of particular importance. Japanese yen swap spreads are shown to contain both pro-cyclical and counter-cyclical elements of business cycle risk, positive risk premia for skewness risk and variable risk premia for correlation risk (between fixed and floating interest rates).

An Empirical Analysis of US Interest Rate Swap Spreads during the Sovereign Crisis of the Euro Zone

This paper analyzes US interest rate swap spreads in relation to the sovereign crisis of the Euro zone. The results reveal that swap spreads of 5- and 10-years incorporate default risk positively in accordance with the theory. According to Ito (2010) which analyzed the period of global financial crisis stemming from subprime loan problem in the US, the default risk is negatively incorporated in the period of financial crisis stemming from US sub-prime loan. This is mainly due to the difference of magnitude of the two crises. The impact of the sovereign crisis of the Euro zone was not as great as the previous crisis. On the other hand, the impacts of slope, TED spread, and volatility are similar to Ito (2010). Steeper yield curve causes narrower swap spreads in swap spreads of 2- and 10-year. When liquidity gets tighter in money market, swap spreads of 2- and 5-year get wider. The size of impact is larger in 2-year swap spread. Higher volatility causes the widening of swap spreads in 5- and 10-year. This is mainly because the market participants were uncertain as for the future of monetary policy by the FRB. DOI: 10.5901/mjss.2013.v4n10p198

Determinants of New Taiwan Dollar Interest Rate Swap Spreads

This study examines the determinants of New Taiwan Dollar interest rate swap spreads. Prior literature provides evidence that the term structure of interest rates, liquidity, and credit risk comprise the swap spreads. The empirical results for the full sample period show that these factors are all important in affecting the swap spreads and that default risk is the most important factor among the five components. Furthermore, default risk plays a more important role than other factors in a bear market, but the key factor varies with the maturities of swap contracts in a bull market.

Determinants of interest rate swap spreads in the US: bounds testing approach to cointegration

This article empirically analyses the determinants of US interest rate swap spreads, and makes two key contributions. First, it considers the nonstationarity of time series, which previous studies have not done, and conducts a cointegration test using the bounds testing approach. The empirical results reveal that there exists a cointegration relationship between interest rate swap spreads and four determinants: the corporate bond spread, the slope of the yield curve, the T bill and Eurodollar (TED) spread and yield volatility. Second, it analyses the determinants of swap spreads using the Dynamic Ordinary Least Squares (DOLS). Considering the cointegration relationship, all explanatory variables were significant within the 5% level.

Covered Interest Rate Arbitrage Trading and Negative Spreads of Interest rate Swap in Korea

This paper empirically shows that the long-term persistence of negative swap spreads, which was unique phenomenon only in Korean interest rate swap market, could be caused by the covered interest rate arbitrage trading by foreign investors in Korean market. It concretely shows the fixed rates of currency swap, whose decreases expand the incentive for arbitrage trading by foreign investors, to positively influence the interest rate swap spreads. The empirical results suggests that the foreign factors might make more effect on the interest rate swap market than the spot bond market, resulting in the negative interest rate swap spreads. The results implies that, the asset pricing for interest rate swap needs to consider the foreign factors under the circumstances of open capital market.

Global financial crisis and US interest rate swap spreads

This article investigates the determinants of US interest rate swap spreads in the period including the financial crisis. The asymmetric impacts of the financial crisis on interest rate swap spreads are focused by dividing the whole sample period into two. Four determinants of swap spreads – default risk, the slope of yield curve, T-bill and EuroDollar (TED) spread and volatility – are chosen. The default risk measured both in Aaa and Baa corporate bonds are negatively incorporated in the period of financial crisis. The slope is positively incorporated in short- and long-term maturities in the period of financial crisis. The liquidity premium is positively incorporated in short- and long-term maturities in normal period and only in short-term maturity in the period of financial crisis. The market participants were uncertain as for the future of monetary policy by Federal Reserve Board (FRB). Thus the speculation on the path of monetary policy is considered to cause more volatility in the market. The volat...

The Interest Rate Swap Spreads and Monetary Policy in Japan

This paper investigates the determinants of interest rate swap spreads in Japan by considering the difference of monetary policy regimes by the Bank of Japan (BOJ). Four determinants of swap spreads - corporate bond spread, TED spread, the slope of yield curve and volatility - are chosen. When the monetary policy was easing, swap spreads decreased as credit risk increased. When monetary policy was tightening, 10-year swap spread decreased in accordance with the increase of corporate bond spread. TED spread contributed to swap spreads positively in all maturities under tightening cycle of the monetary policy. Slope of yield curve contributed more actively to the swap spreads in all maturities in quantitative easing period and to the swap spreads of 5 years, 7 years and 10 years in tightening aspect. Volatility contributed more actively to the swap spreads in all maturities in easing phase.

Modelling Australian interest rate swap spreads by mixture autoregressive conditional heteroscedastic processes

The observed difference between the swap rate and the government bond yield of corresponding maturity is known as the swap spread. The swap spread reflects the risk premium that is involved in a swap transaction instead of holding risk-free government bonds. It is primarily composed of the liquidity risk premium and the credit risk premium. In recent years there has been growing interest in modelling swap spreads because the swap spread is the key pricing variable for the swap rate. The Australian interest rate swap market is the most important over-the-counter (OTC) derivative market in Australia. In this paper we apply the class of mixture autoregressive conditional heteroscedastic (MARCH) models to three (3-year, 5-year and 10-year) swap spread series in Australia. The MARCH model is able to capture both of the stylised characteristics of the observed changes of the swap spread series: volatility persistence and the dependence of volatility on the level of the data. The proposed MARCH model also allows for regime switches in the swap spreads.

Forecasting interest rate swap spreads using domestic and international risk factors: evidence from linear and non‐linear models

AbstractThis paper explores the ability of factor models to predict the dynamics of US and UK interest rate swap spreads within a linear and a non‐linear framework. We reject linearity for the US and UK swap spreads in favour of a regime‐switching smooth transition vector autoregressive (STVAR) model, where the switching between regimes is controlled by the slope of the US term structure of interest rates. We compare the ability of the STVAR model to predict swap spreads with that of a non‐linear nearest‐neighbours model as well as that of linear AR and VAR models. We find some evidence that the non‐linear models predict better than the linear ones. At short horizons, the nearest‐neighbours (NN) model predicts better than the STVAR model US swap spreads in periods of increasing risk conditions and UK swap spreads in periods of decreasing risk conditions. At long horizons, the STVAR model increases its forecasting ability over the linear models, whereas the NN model does not outperform the rest of the models. Copyright © 2007 John Wiley & Sons, Ltd.

Determinants of Japanese Yen interest rate swap spreads: Evidence from a smooth transition vector autoregressive model

AbstractThis study investigates the determinants of variations in the yield spreads between Japanese yen interest rate swaps and Japan government bonds for a period from 1997 to 2005. A smooth transition vector autoregressive (STVAR) model and generalized impulse response functions are used to analyze the impact of various economic shocks on swap spreads. The volatility based on a GARCH (generalized autoregressive conditional heteroskedasticity) model of the government bond rate is identified as the transition variable that controls the smooth transition from a high volatility regime to a low volatility regime. The break point of the regime shift occurs around the end of the Japanese banking crisis. The impact of economic shocks on swap spreads varies across the maturity of swap spreads as well as regimes. Overall, swap spreads are more responsive to the economic shocks in the high volatility regime. Moreover, a volatility shock has profound effects on shorter maturity spreads, whereas the term structure shock plays an important role in impacting longer maturity spreads. Results of this study also show noticeable differences between the nonlinear and linear impulse response functions. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:82–107, 2008

The analysis of interest rate swap spreads in Japan

The purpose of this article is to investigate the determinants of interest rate swap spreads in Japan. Four determinants of swap spreads – TED spread, corporate bond spread, interest rate and the slope of yield curve – are chosen. The swap spreads of 2 years through 4 years are mostly influenced by TED spread, interest rate and slope. The swap spread of 5 years is mostly decided by corporate bond spread and slope. The swap spreads of 7 years and 10 years are mostly affected by corporate bond spread.

Determinants of UK swap spreads

The main factors which drive swap spreads are interest rates, credit risks and liquidity risks. The study uses UK data from 1 January 2001 to 30 June 2004 to analyse the components of interest rate swap spreads. This paper updates previous empirical evidence and considers if different economic and market conditions can have an impact on determinants of swap spreads. It is found that the level and slope of interest rates are significantly positively related to UK swap spreads for most maturities. This differs from previous empirical evidence. It is concluded that differing economic and market conditions can have an impact on swap spreads. Consistent with previous evidence a positive relation between the default risk factor and swap spreads is also found and the liquidity premium is positively related to UK swap spreads for medium- and long-term swap spreads.

The effect of Fed monetary policy regimes on the US interest rate swap spreads

This paper analyzes the asymmetric impacts of various economic shocks on swap spreads under distinct Fed monetary policy regimes. The results indicate that (a) during periods of aggressive interest rate reductions, slope of the Treasury term structure accounts for a sizeable share of the swap spread variance although default shock is also a major player. (b) On the other hand, liquidity premium is the only contributor to the 2-year swap spread variance in monetary tightening cycles. (c) The impact of default risk varies across both monetary cycles and swap maturities. (d) The effect of interest rate volatility is generally more evident in loosening monetary regimes.

Fiscal policy events and interest rate swap spreads: Evidence from the EU

This paper assesses the importance given in capital markets to the credibility of the European fiscal framework. We evaluate to which extent relevant fiscal policy events taking place in 2002 produced a reaction in the long-term bond segment of European capital markets. Firstly, we identify the relevant fiscal policy events. Secondly, we estimate the impact of these fiscal events on interest rate swap spreads in 13 EU member states. According to our results the reaction of swap spreads, when significant, has been mostly around five basis points or less.

Expected Budget Deficits and Interest Rate Swap Spreads - Evidence for France, Germany and Italy

This study analyses whether expected budget deficits have an impact on interest rate swap spreads in France, Germany and Italy. We use monthly deficit forecasts from financial market participants to take the forward-looking behaviour of financial markets into account. Results of a SUR estimation show no significant impact of expected deficits on swap spreads over the whole sample period (1994-2004). However, we find an increase in market discipline for Germany and France since the signing of the Stability and Growth Pact, and for Germany also since the start of European monetary union.