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An Analytic Solution for Interest Rate Swap Spreads

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  • Mark Grinblatt

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. N

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  • Mark Grinblatt, 2002. "An Analytic Solution for Interest Rate Swap Spreads," Yale School of Management Working Papers ysm39, Yale School of Management.
    • Handle: RePEc:ysm:somwrk:ysm39
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    File URL: http://icfpub.som.yale.edu/publications/2411
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    1. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 5, pages 129-164, World Scientific Publishing Co. Pte. Ltd..
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