An Empirical Analysis of Interest Rate Swap Spreads

 

Keith C. Brown

W. V. Harlow

Donald J. Smith

 

Journal of Fixed Income 3, 1994, pp. 61-78

 

 

Abstract

                       

We test several hypotheses about historical movements in interest rate swap spreads, defined as the difference between the fixed rate on a swap and the Treasury yield of corresponding maturity.  Using a sample of weekly observations from 1985 to 1991 we show that these spreads have been significantly related to the difference in levels of the Treasury yield curves for coupon-bearing and zero-coupon securities, forecasts of the spread between three-month LIBOR and Treasury bill yields, the overnight rate on repurchase agreements, and the default risk premium on corporate bonds.  We show that short-term and long-term swaps are priced differently, and that these pricing relationships have changed considerably over time.  On balance, these findings support the premise of an efficient swaps market.

 

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