TED Spread Research Articles

An Extended Macro-Finance Model with Financial Factors

This paper extends the benchmark Macro-Finance model by introducing, next to the standard macroeconomic factors, additional liquidity-related and return forecasting factors. Liquidity factors are obtained from a decomposition of the TED spread while the return-forecasting (risk premium) factor is extracted by imposing a single factor structure on the one-period expected excess holding returns. The model is estimated on US data using MCMC techniques. Two findings stand out. First, the model outperforms significantly most structural and non-structural Macro-Finance yield curve models in terms of cross-sectional fit of the yield curve. Second, we find that financial shocks, either in the form of liquidity or risk premium shocks, have a statistically and economically significant impact on the yield curve. The impact of financial shocks extends throughout the yield curve but is most pronounced at the high and intermediate frequencies.

When and How US Dollar Shortages Evolved into the Full Crisis? Evidence from the Cross-Currency Swap Market

This paper investigates when and how the US dollar shortage problem evolved into the full crisis during the financial turmoil that started in the summer of 2007, using cross-currency swap prices between three European currencies (EUR, GBP, and CHF) and USD. We employ the dynamic global (latent) factor model with regime-switching beta coefficients proposed by Kim (1994). The main findings are as follows. The global factor exists and there are 2 (high and low) distinctive regimes for beta coefficients of each observable price with respect to the global factor. The crisis indicators such as US and European financial credit spreads and TED spread have significant predictive power for regime-switching from and to the high-beta crisis regime. The 1-year market first entered the crisis regime soon after the onset of the subprime problem in August 2007, and has stayed in the crisis regime since early March, 2008. The 5-year market shows more gradual and delayed movements of both the global factor and the crisis regime probability, entering the crisis regime just after the collapse of Bear Sterns in mid-March, 2008.

Sell-Order Illiquidity and the Cross-Section of Expected Stock Returns

We estimate buy- and sell-order illiquidity measures (lambdas) for a comprehensive sample of NYSE stocks. We show that sell-order liquidity is priced more strongly than buy-order liquidity in the cross-section of equity returns. Indeed, our analysis indicates that the liquidity premium in equities emanates predominantly from the sell-order side. We also find that the average difference between sell and buy lambdas is generally positive throughout our sample period. Both buy and sell lambdas are significantly positively correlated with measures of funding liquidity such as the TED spread as well option implied volatility. .

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.

From Default Correlation to Implied Hazard Rate Densities

In this paper I show that the standard deviation of a CDO implied hazard rate density increases with increased correlation between firms' default intensity processes. This is done by generating CDO tranches spreads from a model where firms' defaults are modelled by jump-diffusion hazard rate processes that are correlated through systematic jumps, correlation in the processes' random shocks, or both. The increase in the standard deviation of a CDO implied hazard rate density holds irrespective of how the jump-diffusion hazard rate processes' are correlated. In addition, model simulations indicate that systematic jumps that are rare and with large mean size are required to yield senior CDO tranche model spreads that are consistent with market quotes. This observations supports similar conclusions reported in the existing literature. Further to this, I propose a model where the default of one firm triggers the default of other firms. When the number of firms hit by this default is approximately 1/3 of a CDO's reference portfolio, I am able to produce model spreads that are within range of the extreme spreads observed during the 2007-2008 credit crisis. In addition, using a vector autoregression on daily observations, I provided evidence that lags of the standard deviation of the implied hazard rate density and the spread of the 3-month Eurodollar and 3-month T-Bill rates (TED spread) are factors for one-period ahead prediction of each other.

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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.

Relationship between Treasury bills and Eurodollars: Theoretical and Empirical Analyses

In this paper, we derive an equilibrium relationship between the yields on Eurodollar and Treasury bills based on equivalent martingale results derived by Harrison and Kreps (1979) and Harrison and Pliska (1981, 1983) as well as the corporate debt pricing model developed by Merton (1974). The derived equilibrium relationship incorporates the models used by Booth and Tse (1995) and Shrestha and Welch (2001) as special cases. The equilibrium relationship indicates that the conditional volatility of the yield on Eurodollars explains the variation in the TED spread. We empirically test the equilibrium relationship using a GARCH-M model and the concept of fractional cointegration. We use both the ex ante data implied by the respective futures contracts as well as the ex post spot data with daily, weekly and monthly frequencies. We find empirical support for the Equilibrium relationship.

Common volatility and volatility spillovers between U.S. and Eurodollar interest rates: Evidence from the futures market

U.S. Treasury bill and Eurodollar futures are employed to investigate volatility spillovers between U.S. and Eurodollar interest rates. The paper shows that both interest rates follow a GARCH process but they do not share a common volatility factor. A bivariate EGARCH model that allows for the asymmetric volatility influence of the interest rate differential between markets (the TED spread), as well as that of the domestic market, is used to analyze the volatility spillovers between markets. Results show that the lagged TED spread change is the driving force of the volatility process.

The relationship between U.S. and eurodollar interest rates: Evidence from the futures market

The Relationship between U.S. and Eurodollar Interest Rates: Evidence from the Futures Market. — This paper analyzes the lead/lag relationship in the Granger-cause sense between U.S. and Eurodollar interest rates in futures contracts. It shows that yields on U.S. Treasury bill and Eurodollar futures are cointegrated with the TED spread as the cointegrating vector for the period January 1987–July 1993. The error correction model indicates that the U.S. market leads the Eurodollar market. However, the presence of this unidirectional causality does not improve the forecasting of Eurodollar yields. Other evidence given in the paper suggests that the hypothesis of contemporaneous relationships, at least on daily base, is not rejected.