Determinants of Swap Spreads in a Developing Financial Market: Evidence from Finland

Abstract

This paper presents empirical evidence on the determinants of swap spreads in Finland using four years of data. Spreads exhibit a significant negative relationship with the amount of fixed rate deposits with banks, which reflects the importance of banks in the Finnish capital markets. Spreads are positively linked to business cycle and market risk factors such as the slope of the yield curve and the volatility of interest rates. The influence of hedging costs has become increasingly important over time, especially in longer dated swaps. A relationship is also observed between swap spreads and the external value of the currency.

Determinants of Japanese Yen interest rate swap spreads: Evidence from a smooth transition vector autoregressive model

“…The impulse response of SS2 to the term structure shock also displays an asymmetric pattern. A positive, though small response is observed in the first regime, which is in agreement with the findings reported in Alworth (1993) for the U.S. dollar swap spreads, and Suhonen (1998) for Finland data. The swap spread's response to the term structure shock, however, is virtually nil in the second regime.…”

“…Suhonen (1998) and Milas (2001) study interest rate swaps using both U.S. and U.K. data. Lekkos and Milas (2004) model U.S. and U.K. swap spreads within an STVAR framework allowing for steep or flat yield curve slopes.…”

Low-Frequency Volatility of Yen Interest Rate Swap Market in Relation to Macroeconomic Risk*

“…Volatility series for CPI (consumer price index), IP (industrial production), IR (interest rate -90days TB rate) and foreign exchange rates are obtained from the (absolute value of) residuals of AR (1) The FXVOL has a positive and statistically significant influence on the lowfrequency volatility of all swaps. Suhonen (1998) also finds positive but statistically weak relationship between the volatility of foreign exchange and swap spread. To reiterate, a positive relationship suggests that when the exchange rate is highly volatile, the cross-border counterparties demand more payer positions, which increase the demand for swaps and affects the swap markets.…”

“…A country's exchange rate can be affected by different channels including inflation, interest rates differential and foreign exchange carry trade (Andersen et al 2003b;Simpson et al 2005). Suhonen (1998) finds that a part of interest rate volatility is transmitted into exchange rates, which makes currency movements an important issue in swap pricing. If the exchange rate is highly volatile, the cross-border counterparties demand more payer positions, thereby affecting the swap markets.…”

Linking the interest rate swap markets to the macroeconomic risk: The UK and us evidence

“…Azad et al (2011) conduct an analysis of full sample and sub-samples to identify the variation in relationship during the crisis periods. Suhonen (1998) argues that when the exchange rate is highly volatile, the cross-border counterparties demand more payer positions, thereby increasing the swap rate and its volatility. Of the other macroeconomic variables, the SLOPE coefficient is positive and significant throughout all swaps maturities for the US.…”