International Swap Market Contagion and Volatility

46 Pages Posted: 7 Feb 2015

See all articles by A. S. M. Sohel Azad

A. S. M. Sohel Azad

Deakin University

Jonathan A. Batten

RMIT University

Victor Fang

Deakin University

J. Wickramanayake

Monash University - Department of Accounting; Financial Research Network (FIRN)

Date Written: February 4, 2015

Abstract

Using interest rate swap yield and spread data the linkages and volatility transmission between three major international swap markets: Japan, UK and the US are investigated. The volatilities of the swap yield and spreads are decomposed into long and short term components enabling an assessment to be made of the strength and direction of the volatility transmission process between the three markets. Strength is measured through the dynamic correlation between the long and short-term components, while direction is measured through the causality of these components. The contagion effects of key economic events are also considered. The paper presents three key findings. First, cross-market correlations of both short and long-term components between Japan and the US, and Japan and the UK are very low, which is consistent with weak integration. This would motivate international investors to take advantage of the differential between the lower long-term yields of Japanese Government bonds and the higher long-term yields of US bonds. On the other hand the cross-market correlations between the UK and the US are high, which is consistent with strong integration. Second, contagion exists in both the long and short-term volatility components of the swap spread, but not on the swap rates. Third, in terms of the direction of transmission, the volatility spillovers (both components) are mostly multidirectional between the markets.

Keywords: Financial Integration; Interest Rate Swap; Long-term Volatility; Short-term Volatility; Long-term Correlations; Short-term Correlations

JEL Classification: C53; G11; G12

Suggested Citation

Azad, A. S. M. Sohel and Batten, Jonathan A. and Fang, Victor and Wickramanayake, Jayasinghe, International Swap Market Contagion and Volatility (February 4, 2015). Economic Modelling, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2561058

A. S. M. Sohel Azad (Contact Author)

Deakin University ( email )

221 Burwood Highway
Burwood
Melbourne, Victoria 3125
Australia

Jonathan A. Batten

RMIT University ( email )

Level 12, 239 Bourke Street
Melbourne, Victoria
Australia

HOME PAGE: http://https://www.rmit.edu.au/contact/staff-contacts/academic-staff/b/batten-professor-jonathan

Victor Fang

Deakin University ( email )

School of Acc Economics Finance
Burwood Highway
Burwood, Victoria 3215
Australia
92446919 (Phone)

HOME PAGE: http://www.deakin.edu.au

Jayasinghe Wickramanayake

Monash University - Department of Accounting ( email )

Building 11E
Clayton, Victoria 3800
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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