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Impact of credit spreads, monetary policy and convergence trading on swap spreads

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  • Chung, Hon-Lun
  • Chan, Wai-Sum

Abstract

We investigate the determinants of US swap spreads based on the development of the swap market and the major events that happened between 1991 and 2006. We find that changes in swap spreads are jointly determined by the liquidity premium, interest rate level, default risk premium and the business cycle. The changes in swap spreads are positively related to liquidity premium, interest rate level and the slope of risk-free term structure. Amongst the various credit spreads, Finance AA spreads and agency spreads have the most influence on swap spreads. We also find that swap spreads changed from pro-cyclical to counter-cyclical after 1999. When the market features heavy speculative trading, such as the convergence trading activities of swap spreads, the magnitude of swap spreads is affected and their behaviour becomes uncertain.

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  • Chung, Hon-Lun & Chan, Wai-Sum, 2010. "Impact of credit spreads, monetary policy and convergence trading on swap spreads," International Review of Financial Analysis, Elsevier, vol. 19(2), pages 118-126, March.
    • Handle: RePEc:eee:finana:v:19:y:2010:i:2:p:118-126
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    3. Toyoshima, Yuki & Tamakoshi, Go & Hamori, Shigeyuki, 2012. "Asymmetric dynamics in correlations of treasury and swap markets: Evidence from the US market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(2), pages 381-394.
    4. Batten, Jonathan A. & Jacoby, Gady & Liao, Rose C., 2014. "Corporate yield spreads and real interest rates," International Review of Financial Analysis, Elsevier, vol. 34(C), pages 89-100.
    5. Mitra, Sovan & Date, Paresh & Mamon, Rogemar & Wang, I-Chieh, 2013. "Pricing and risk management of interest rate swaps," European Journal of Operational Research, Elsevier, vol. 228(1), pages 102-111.

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