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

64 Pages Posted: 19 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: February 2018

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: duration, swap spreads, balance sheet constraints, funding status of pension plans, defined benefits, repo, LIBOR

JEL Classification: D40, G10, G12, G13, G15, G22, G23

Suggested Citation

Klingler, Sven and Sundaresan, Suresh M., An Explanation of Negative Swap Spreads: Demand for Duration from Underfunded Pension Plans (February 2018). BIS Working Paper No. 705. Available at SSRN: https://ssrn.com/abstract=3125014

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/

Register to save articles to
your library

Register

Paper statistics

Downloads
61
Abstract Views
313
rank
49,373
PlumX Metrics