Modelling the US swap spread

Abstract

The dynamics between five-year US Treasury bonds and interest rate swaps are examined using bivariate threshold autoregressive (BTAR) models to determine the drivers of spread changes and the nature of the lead–lag relation between the two instruments. This model is able to identify the economic – or threshold – value that market participants consider significant before realigning their portfolios. Specifically, three different regimes are identified: when the swap spread in the previous week is either high or low, the Treasury bond market leads the swap market. However, when the swap spread is low, none of the markets leads each other. Thus, yield movements are shown to be governed by the direction and magnitude of the change in the swap spread, which in turn provides an economic insight into the rebalancing between swap and bond portfolios.

Citation

Chung, H.-L., Chan, W.-S. and Batten, J.A. (2010), "Modelling the US swap spread", Kensinger, J.W. (Ed.) Research in Finance (Research in Finance, Vol. 26), Emerald Group Publishing Limited, Leeds, pp. 155-181. https://doi.org/10.1108/S0196-3821(2010)0000026010