Linking the Interest Rate Swap Markets to the Macroeconomic Risk: The UK and US Evidence

Posted: 7 Feb 2015

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

A. S. M. Sohel Azad

Deakin University

Victor Fang

Deakin University

Chi-Hsiou Daniel Hung

University of Glasgow - Adam Smith Business School

Date Written: March 5, 2012

Abstract

In this paper we aim to link the volatility of interest rate swap (hereafter, IRS) markets to the macroeconomic risk/uncertainty of the UK and the US. In doing so, we obtain the low-frequency volatility of IRS using a recently developed Asymmetric Spline GARCH (ASP-GARCH) model of Rangel and Engle (2012). Our findings suggest a strong relationship between uncertainties of macroeconomic fundamentals and the fluctuation in swap market volatility. The association between the two is robust with respect to the choice of different alternative measures of volatility that are used in the literature on GARCH modelling. From the perspectives of practical implications, the findings suggest that policy makers should use low-frequency volatility in order to examine market responses to key macroeconomic policies, and that market participants may rely on low-frequency volatility to extract trading signals. Using such signals, hedgers could make forecast of whether they need to increase (decrease) IRS usage to hedge risk originating from macroeconomic uncertainty.

Keywords: Interest Rate Swaps; Low-frequency Volatility; Macroeconomic Risk

JEL Classification: E43; G12

Suggested Citation

Azad, A. S. M. Sohel and Fang, Victor and Hung, Chi-Hsiou Daniel, Linking the Interest Rate Swap Markets to the Macroeconomic Risk: The UK and US Evidence (March 5, 2012). International Review of Financial Analysis, Vol. 22, 38-47, 2012, Available at SSRN: https://ssrn.com/abstract=2561068

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

Deakin University ( email )

221 Burwood Highway
Burwood
Melbourne, Victoria 3125
Australia

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

Chi-Hsiou Daniel Hung

University of Glasgow - Adam Smith Business School ( email )

Gilbert Scott Building
University of Glasgow
Glasgow, Scotland G12 8QQ
United Kingdom

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