Modeling Swap Spreads in Normal and Stressed Environments

28 Pages Posted: 24 Dec 2008

See all articles by Vineer Bhansali

Vineer Bhansali

LongTail Alpha, LLC

Yonathan Schwarzkopf

Lime Brokerage LLC; Santa Fe Institute

Mark B. Wise

California Institute of Technology

Date Written: December 24, 2008

Abstract

We develop a simple integrated model for the term structure of swap spreads. We begin with a model for explaining the dynamics of the riskless treasury curve in terms of two factors. We add to the basic model additional inputs that describe the evolution of the implied hazard rate intensity for interest rate swaps. Based on the model, we can derive closed form expressions for observables such as the shape of the term structure of swap spreads, term structure of volatilities and correlations. Our model is economically motivated, and is appealing in its simplicity and robustness in being able to explain the dynamics of the swap spread term structure in both normal and stressed markets. We apply the technique to swap-spread term structures for various international markets.

Suggested Citation

Bhansali, Vineer and Schwarzkopf, Yonathan and Wise, Mark B., Modeling Swap Spreads in Normal and Stressed Environments (December 24, 2008). Available at SSRN: https://ssrn.com/abstract=1319765 or http://dx.doi.org/10.2139/ssrn.1319765

Vineer Bhansali

LongTail Alpha, LLC ( email )

500 Newport Center Drive
Suite 820
Newport Beach, CA 92660
United States

Yonathan Schwarzkopf (Contact Author)

Lime Brokerage LLC ( email )

625 Broadway
New York, NY 10012
United States

Santa Fe Institute

1399 Hyde Park Road
Santa Fe, NM 87501
United States

Mark B. Wise

California Institute of Technology ( email )

Pasadena, CA 91125
United States
626-395-6687 (Phone)
626-568-8473 (Fax)

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