An Explanation of Negative Swap Spreads: Demand for Duration from Underfunded Pension Plans

61 Pages Posted: 28 Jul 2016 Last revised: 21 Feb 2018

See all articles by Sven Klingler

Sven Klingler

BI Norwegian Business School

Suresh M. Sundaresan

Columbia Business School - Finance and Economics

Multiple version iconThere are 2 versions of this paper

Date Written: October 4, 2016

Abstract

The 30-year U.S. swap spreads have been negative since September 2008. We offer a novel explanation for this persistent anomaly. Through an illustrative model, we show that underfunded pension plans optimally use swaps for duration hedging. Combined with dealer banks' balance sheet constraints, this demand can drive swap spreads to become negative. Empirically, we construct a measure of the aggregate funding status of Defined Benefit pension plans and show that this measure is a significant explanatory variable of 30-year swap spreads. We find a similar link between pension funds' underfunding and swap spreads for two other regions.

Keywords: Pension funds, liability-driven investment, swap spreads, pension protection act, swap rates, limits of arbitrage

JEL Classification: G11, G12, G13, G22, G23

Suggested Citation

Klingler, Sven and Sundaresan, Suresh M., An Explanation of Negative Swap Spreads: Demand for Duration from Underfunded Pension Plans (October 4, 2016). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2814975 or http://dx.doi.org/10.2139/ssrn.2814975

Sven Klingler (Contact Author)

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

Suresh M. Sundaresan

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
212-854-4423 (Phone)
212-316-9180 (Fax)

HOME PAGE: http://www0.gsb.columbia.edu/faculty/ssundaresan/

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