Interrelations Among Cross-Currency Basis Swap Spreads: Pre-And Post-Crisis Analysis

Abstract

We examine the long-run relationships and short-run dynamic linkages among 9 major cross-currency swap spreads, with specific emphasis on how crisis periods have impacted the long-run relationships and short-run dynamic transmissions. The results show that the long-run relationships were slightly weakened after the crisis, while the short-run dynamic linkages were generally strengthened. The influence of euro and swiss cross-currency swaps on other European cross-currency swaps generally increased after the crisis; the swiss cross-currency swap became several times more influential on all European cross-currency swaps. Our findings are robust to alternative reordering of the variables in our 9-variable VAR system, computation of generalized impulse response functions and consideration of rolling variance decompositions. Overall, our results can be summarized, as follows, in the spirit of Newton’s first law of motion: Post crisis, there is a reluctance for the cross-currency swaps to wander as the short-run linkages between them have strengthened. But when these links break (due, perhaps, to a system-wide shock), setting the swaps in motion, the swaps would be again reluctant to revert to their previous state of equilibrium because their speed of convergence has slowed, and hence their long-run relationships have weakened.

Keywords: Cross-Currency Basis Swap Spreads, Swap Markets, Pre-and-Post Crisis

JEL Classification: C32, D53, F31, G01