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An Analytic Solution for Interest Rate Swap Spreads

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Author Info
Mark Grinblatt () (Finance Area)

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Abstract

This paper argues that liquidity differences between government securities and short term Eurodollar borrowings account for interest rate swap spreads. It then models the convenience of liquidity as a linear function of two mean-reverting state variables and values it. The interest rate swap spread for a swap of particular maturity is the annuitized equivalent of this value. It has a closed form solution: a simple integral. Special cases examined include the Vasicek (1977) and Cox-Ingersoll-Ross (1985) one-factor term structure models. Numerical values for the parameters in both special cases illustrate that many realistic "swap spread term structures" can be replicated. Model parameters are estimated using weekly data on the "term structure of swap spreads" from several countries. The model fits the data well.

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Paper provided by Yale School of Management in its series Yale School of Management Working Papers with number ysm39.

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Date of creation: 21 Jan 2002
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Handle: RePEc:ysm:somwrk:ysm39

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E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates

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  1. Cooper, Ian A & Mello, Antonio S, 1991. " The Default Risk of Swaps," Journal of Finance, American Finance Association, vol. 46(2), pages 597-620, June. [Downloadable!] (restricted)
  2. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November. [Downloadable!] (restricted)
  3. Sarig, Oded & Warga, Arthur, 1989. "Bond Price Data and Bond Market Liquidity," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 24(03), pages 367-378, September. [Downloadable!]
  4. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March. [Downloadable!] (restricted)
  5. Warga, Arthur, 1992. "Bond Returns, Liquidity, and Missing Data," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(04), pages 605-617, December. [Downloadable!]
  6. Amihud, Yakov & Mendelson, Haim, 1991. " Liquidity, Maturity, and the Yields on U.S. Treasury Securities," Journal of Finance, American Finance Association, vol. 46(4), pages 1411-25, September. [Downloadable!] (restricted)
  7. Sun, Tong-sheng & Sundaresan, Suresh & Wang, Ching, 1993. "Interest rate swaps: An empirical investigation," Journal of Financial Economics, Elsevier, vol. 34(1), pages 77-99, August. [Downloadable!] (restricted)
  8. Litzenberger, Robert H, 1992. " Swaps: Plain and Fanciful," Journal of Finance, American Finance Association, vol. 47(3), pages 831-50, July. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Jun Liu & Francis A. Longstaff & Ravit E. Mandell, 2002. "The Market Price of Credit Risk: An Empirical Analysis of Interest Rate Swap Spreads," NBER Working Papers 8990, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Ravi Jagannathan & Andrew Kaplin & Steve Guoqiang Sun, 2001. "An Evaluation of Multi-Factor CIR Models Using LIBOR, Swap Rates, and Cap and Swaption Prices," NBER Working Papers 8682, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Rong Fan & Joseph G. Haubrich & Peter Ritchken & James B. Thomson, 2002. "Getting the most out of a mandatory subordinated debt requirement," Working Paper 0214, Federal Reserve Bank of Cleveland. [Downloadable!]
    Other versions:
  4. Arvind Krishnamurthy & Annette Vissing-Jorgensen, 2007. "The Demand for Treasury Debt," NBER Working Papers 12881, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Ilias Lekkos & Costas Milas, 2002. "Common risk factors in the US and UK interest rate swap markets:Evidence from a non-linear vector autoregression approach," Economics and Finance Discussion Papers 02-05, Economics and Finance Section, School of Social Sciences, Brunel University. [Downloadable!]
    Other versions:
  6. Joseph Byrne & Alexandros Kontonikas & Alberto Montagnoli, 2007. "Unit Roots in Inflation and Aggregation Bias," Working Papers 2007_07, Department of Economics, University of Glasgow. [Downloadable!]
  7. Jeremy Leake, . "Credit spreads on sterling corporate bonds and the term structure of UK interest rates," Bank of England working papers 202, Bank of England. [Downloadable!]
  8. Gregory R. Duffee, 1996. "Estimating the price of default risk," Finance and Economics Discussion Series 96-29, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  9. Jesus Saa-Requejo & Pedro Santa-Clara, 1997. "Bond Pricing with Default Risk," University of California at Los Angeles, Anderson Graduate School of Management 1127, Anderson Graduate School of Management, UCLA. [Downloadable!]
  10. Jun Liu & Francis Longstaff & Ravit Mandell, 2000. "The Market Price of Credit Risk: An Empirical Analysis of Interest Rate Swap Spreads," University of California at Los Angeles, Anderson Graduate School of Management 1076, Anderson Graduate School of Management, UCLA. [Downloadable!]
  11. Gregory R. Duffee, 1996. "Treasury yields and corporate bond yield spreads: an empirical analysis," Finance and Economics Discussion Series 96-20, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  12. Gordon Delianedis & Robert Geske, 2001. "The Components of Corporate Credit Spreads: Default, Recovery, Tax, Jumps, Liquidity, and Market Factors," University of California at Los Angeles, Anderson Graduate School of Management 1025, Anderson Graduate School of Management, UCLA. [Downloadable!]
  13. SOLNIK, Bruno & COLLIN-DUFRESNE, Pierre, 2000. "On the term structure of default premia in the Swap and Libor markets," Les Cahiers de Recherche 704, HEC Paris. [Downloadable!]
  14. Marti G. Subrahmanyam & Young Ho Eom & Jun Uno, 2000. "Credit Risk and the Pricing of Japanese Yen Interest Rate Swaps," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-069, New York University, Leonard N. Stern School of Business-. [Downloadable!]
  15. Somnath Chatterjee, 2005. "An Investigation Into The Linkages Between Euro And Sterling Swap Spreads," Working Papers 2005_1, Department of Economics, University of Glasgow. [Downloadable!]
  16. Ilias Lekkos & Costas Milas & Theodore Panagiotidis, 2005. "On the predictability of common risk factors in the US and UK interest rate swap markets:Evidence from non-linear and linear models," Keele Economics Research Papers KERP 2005/13, Centre for Economic Research, Keele University. [Downloadable!]
    Other versions:
  17. Hayette Gatfaoui, 2003. "Risque de Défaut et Risque de Liquidité : Une Etude de Deux Composantes du Spread de Crédit," Risk and Insurance 0308005, EconWPA. [Downloadable!]
  18. Cho-Hoi Hui & Lillie Lam, 2008. "What Drives Hong Kong Dollar Swap Spreads: Credit or Liquidity?," Working Papers 0810, Hong Kong Monetary Authority. [Downloadable!]
  19. Antulio N. Bomfim, 2003. "Counterparty credit risk in interest rate swaps during times of market stress," Finance and Economics Discussion Series 2003-09, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  20. Christopher F. Baum & Mustafa Caglayan & Andreas Stephan & Oleksandr Talavera, 2006. "Uncertainty Determinants of Corporate Liquidity," Working Papers 2006_1, Department of Economics, University of Glasgow. [Downloadable!]
    Other versions:
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