What Determines U.S. Swap Spreads?

This paper examines the evolution of the U.S. interest swap market. The authors review the theory and past empirical studies on U.S. swap spreads, and estimate an error-correction model for maturities of 2, 5, and 10 years from 1994 to 2004. Financ...

Full description

Bibliographic Details
Main Authors:	Kobor, Adam, Shi, Lishan, Zelenko, Ivan
Format:	Publication
Language:	English en_US
Published:	Washington, DC: World Bank 2012
Subjects:	FINANCIAL ANALYSIS; STATISTICS; MODELS; ERROR CORRECTION MODELS; COINTEGRATION; SWAP TRANSACTIONS; TREASURY BONDS; YIELD INCREASE; MORTGAGE-BACKED SECURITIES; ANALYTICAL METHODS;
Online Access:	http://documents.worldbank.org/curated/en/2005/06/6258950/determines-swap-spreads http://hdl.handle.net/10986/7272

id	okr-10986-7272
recordtype	oai_dc
spelling	okr-10986-72722021-04-23T14:02:28Z What Determines U.S. Swap Spreads? Kobor, Adam Shi, Lishan Zelenko, Ivan FINANCIAL ANALYSIS; STATISTICS; MODELS; ERROR CORRECTION MODELS; COINTEGRATION; SWAP TRANSACTIONS; TREASURY BONDS; YIELD INCREASE; MORTGAGE-BACKED SECURITIES; ANALYTICAL METHODS; This paper examines the evolution of the U.S. interest swap market. The authors review the theory and past empirical studies on U.S. swap spreads, and estimate an error-correction model for maturities of 2, 5, and 10 years from 1994 to 2004. Financial theory depicts swaps as contracts indexed on London Inter-Bank Offered (LIBOR) rates, rendered almost free of counterparty default risk by mark-to-market and collateralization. Swap spreads reflect the LIBOR credit quality (credit component) and a liquidity convenience premium present in Treasury rates (liquidity component). Multifactor models that were estimated on observed swap rates highlighted the central role played by the liquidity component in explaining swap-spread dynamics over the past 15 years. The multifactor models also found some puzzling empirical results. Statistical models, on the other hand, based mainly on market analysis, faced technical difficulties arising from the presence of regime changes, from the non-stationary in swap spreads, and from the coexistence of long-term and shorter-term determinants. Against this background, the authors apply an error-correction methodology based on the concept of co-integration. They find that U.S. dollar swap spreads and the supply of U.S. Treasury bonds are co-integrated, suggesting that the Treasury supply is a key determinant on a long-term horizon. The authors estimate an error-correction model that integrates this long-term relationship with the influence of four shorter-term determinants: the AA spread, the repo rate, the difference between on-the-run and off-the-run yields, and the duration of mortgage-backed securities. The error-correction model fits observed swap spreads quite well over the sample period. The authors illustrate how the same model can be used to carry out scenario analysis. 2012-06-06T16:22:53Z 2012-06-06T16:22:53Z 2005 http://documents.worldbank.org/curated/en/2005/06/6258950/determines-swap-spreads 978-0-8213-6338-6 http://hdl.handle.net/10986/7272 English en_US World Bank Working Paper No. 62 CC BY 3.0 IGO http://creativecommons.org/licenses/by/3.0/igo World Bank Washington, DC: World Bank Publications & Research :: Publication Publications & Research :: Publication America North America
repository_type	Digital Repository
institution_category	Foreign Institution
institution	Digital Repositories
building	World Bank Open Knowledge Repository
collection	World Bank
language	English en_US
topic	FINANCIAL ANALYSIS; STATISTICS; MODELS; ERROR CORRECTION MODELS; COINTEGRATION; SWAP TRANSACTIONS; TREASURY BONDS; YIELD INCREASE; MORTGAGE-BACKED SECURITIES; ANALYTICAL METHODS;
spellingShingle	FINANCIAL ANALYSIS; STATISTICS; MODELS; ERROR CORRECTION MODELS; COINTEGRATION; SWAP TRANSACTIONS; TREASURY BONDS; YIELD INCREASE; MORTGAGE-BACKED SECURITIES; ANALYTICAL METHODS; Kobor, Adam Shi, Lishan Zelenko, Ivan What Determines U.S. Swap Spreads?
geographic_facet	America North America
relation	World Bank Working Paper No. 62
description	This paper examines the evolution of the U.S. interest swap market. The authors review the theory and past empirical studies on U.S. swap spreads, and estimate an error-correction model for maturities of 2, 5, and 10 years from 1994 to 2004. Financial theory depicts swaps as contracts indexed on London Inter-Bank Offered (LIBOR) rates, rendered almost free of counterparty default risk by mark-to-market and collateralization. Swap spreads reflect the LIBOR credit quality (credit component) and a liquidity convenience premium present in Treasury rates (liquidity component). Multifactor models that were estimated on observed swap rates highlighted the central role played by the liquidity component in explaining swap-spread dynamics over the past 15 years. The multifactor models also found some puzzling empirical results. Statistical models, on the other hand, based mainly on market analysis, faced technical difficulties arising from the presence of regime changes, from the non-stationary in swap spreads, and from the coexistence of long-term and shorter-term determinants. Against this background, the authors apply an error-correction methodology based on the concept of co-integration. They find that U.S. dollar swap spreads and the supply of U.S. Treasury bonds are co-integrated, suggesting that the Treasury supply is a key determinant on a long-term horizon. The authors estimate an error-correction model that integrates this long-term relationship with the influence of four shorter-term determinants: the AA spread, the repo rate, the difference between on-the-run and off-the-run yields, and the duration of mortgage-backed securities. The error-correction model fits observed swap spreads quite well over the sample period. The authors illustrate how the same model can be used to carry out scenario analysis.
format	Publications & Research :: Publication
author	Kobor, Adam Shi, Lishan Zelenko, Ivan
author_facet	Kobor, Adam Shi, Lishan Zelenko, Ivan
author_sort	Kobor, Adam
title	What Determines U.S. Swap Spreads?
title_short	What Determines U.S. Swap Spreads?
title_full	What Determines U.S. Swap Spreads?
title_fullStr	What Determines U.S. Swap Spreads?
title_full_unstemmed	What Determines U.S. Swap Spreads?
title_sort	what determines u.s. swap spreads?
publisher	Washington, DC: World Bank
publishDate	2012
url	http://documents.worldbank.org/curated/en/2005/06/6258950/determines-swap-spreads http://hdl.handle.net/10986/7272
_version_	1764399562432184320

What Determines U.S. Swap Spreads?

Similar Items