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This study investigates the determinants of Japanese interest rate swap spreads in each
subsample by considering different monetary policy regimes. Four determinants of
swap spreads—corporate bond spread, TED spread, slope of yield curve, and volatility—are
chosen. The analysis of interest rate swap spreads is an interesting and important research
topic, because swap spreads contain the price of interest rate swaps and market information.
In Japan, interest rate swap transactions are used by financial institutions and corporations
for risk management. Financial institutions in Japan, especially banks, often use interest
rate swap transactions for Asset-Liability Management (ALM)-related operations.
An interest rate swap is an agreement between two parties to exchange cash flows in
the future. In a typical agreement, two counterparties exchange streams of fixed and
floating interest rate payments. Thus, fixed interest rate payment can be transformed into
floating payment and vice versa. The amount of each floating rate payment is based on a variable
rate that has been mutually agreed upon by both the counterparties. For example, the
floating rate payment could be based on 6-month London Interbank Offer Rate (LIBOR).
The market for interest rate swaps has grown exponentially in the 1990s. According to
a survey by Bank for International Settlements (BIS), the notional outstanding volume
of transactions of interest rate swaps amounted to $328,114 bn at the end of December
2008.1 Differences between swap rates and government bond yields of the same maturity are referred
to as swap spreads. If the swap and government bond markets are
efficiently priced, swap spreads may reveal something about the perception of the systemic risk in the banking sector. |
