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What Drives Swap Spreads, Credit or Liquidity?

Author

Listed:
  • Ying Huang

    (Graduate Center, CUNY)

  • Salih Neftci

    () (Professor, Economics Department, Graduate Center, CUNY)

  • Ira Jersey

    (Credit Suisse First, Boston, New York)

Abstract

This paper investigates the determinants of swap spreads. Compared with previous work done in this area, such as the seminal paper by Duffie and Singleton (1997), the paper includes daily credit spreads data in the time series framework. The issue is whether “liquidity” or “credit” (or both) is the main determinant of swap spreads dynamics. Our results agree with the prevailing view among swap traders that swap spreads are mainly an indicator of “market liquidity”. However, the dynamics are influenced significantly by “credit” over longer horizons, although credit is not the main driving force. LIBOR rate dynamics seem to play a relatively minor role in this setting.

Suggested Citation

  • Ying Huang & Salih Neftci & Ira Jersey, 2002. "What Drives Swap Spreads, Credit or Liquidity?," ICMA Centre Discussion Papers in Finance icma-dp2003-05, Henley Business School, Reading University.
  • Handle: RePEc:rdg:icmadp:icma-dp2003-05
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    File URL: http://www.icmacentre.ac.uk/pdf/discussion/DP2003-05.pdf
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    References listed on IDEAS

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    1. Mark Grinblatt, 2001. "An Analytic Solution for Interest Rate Swap Spreads," International Review of Finance, International Review of Finance Ltd., vol. 2(3), pages 113-149.
    2. Duffie, Darrell & Singleton, Kenneth J, 1997. " An Econometric Model of the Term Structure of Interest-Rate Swap Yields," Journal of Finance, American Finance Association, vol. 52(4), pages 1287-1321, September.
    3. Lang, Larry H. P. & Litzenberger, Robert H. & Luchuan Liu, Andy, 1998. "Determinants of interest rate swap spreads," Journal of Banking & Finance, Elsevier, vol. 22(12), pages 1507-1532, December.
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    Cited by:

    1. Jun Liu & Francis A. Longstaff & Ravit E. Mandell, 2006. "The Market Price of Risk in Interest Rate Swaps: The Roles of Default and Liquidity Risks," The Journal of Business, University of Chicago Press, vol. 79(5), pages 2337-2360, September.
    2. Ingo Fender & Martin Scheicher, 2008. "The ABX: how do the markets price subprime mortgage risk?," BIS Quarterly Review, Bank for International Settlements, September.
    3. Scheicher, Martin & Fender, Ingo, 2009. "The pricing of subprime mortgage risk in good times and bad: evidence from the ABX.HE indices," Working Paper Series 1056, European Central Bank.
    4. Finbarr Murphy & Bernard Murphy, 2012. "A vector-autoregression analysis of credit and liquidity factor dynamics in US LIBOR and Euribor swap markets," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 36(2), pages 351-370, April.

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