Japanese Interest Rate Swap Pricing

This paper investigates the two questions on the pricing of interest rate swap in the Japanese market by applying a time varying coefficient regression model: (i) Do the risk factors which determine the spread in the US market also hold in the Japanese market? (ii) How does the degree of sensitivity of the swap spread to the risks vary over time (in particular, focusing on the impact of the "Asian financial crisis" and the "global financial crisis")? Both default risk of counter party and liquidity risk price the swap spread in the Japanese interest rate swap market. But, influences to swap pricing of these two risks are somewhat different. Roughly speaking, liquidity risk plays more important role in shorter maturities and default risk is more important for longer maturities. The above two kind of risks play different roles during the financial crises of the "Asian financial crisis" in 1997 to 1998 and the "global financial" crisis from 2007. The liquidity risk was a key factor in the former crisis, but not in the latter crisis for longer maturities. Default risk of LIBOR does not clearly display any determinants in the Japanese markets.