Demand-and-Supply Imbalance Risk and Long-Term Swap Spreads

98 Pages Posted: 23 Dec 2022 Last revised: 17 Jul 2023

See all articles by Samuel Gregory Hanson

Samuel Gregory Hanson

Harvard University - Business School (HBS)

Aytek Malkhozov

McGill University

Gyuri Venter

Warwick Business School

Date Written: July 14, 2023

Abstract

We develop and test a model in which swap spreads are determined by end users’ demand for and constrained intermediaries’ supply of long-term interest rate swaps. Swap spreads reflect compensation both for using scarce intermediary capital and for bearing convergence risk—i.e., the risk spreads will widen due to a future demand-and-supply imbalance. We show that a proxy for the intermediated quantity of swaps—dealers’ net position in Treasuries—flipped sign during the Global Financial Crisis when swap spreads turned negative and that this variable predicts the excess returns on swap spread trades. Exploiting our model’s sign restrictions, we identify shifts in demand and supply and find that both contribute significantly to the volatility of swap spreads.

Keywords: swap spreads, limits to arbitrage, intermediary capital constraints

JEL Classification: G12, E43

Suggested Citation

Hanson, Samuel Gregory and Malkhozov, Aytek and Venter, Gyuri, Demand-and-Supply Imbalance Risk and Long-Term Swap Spreads (July 14, 2023). Available at SSRN: https://ssrn.com/abstract=4301140 or http://dx.doi.org/10.2139/ssrn.4301140

Samuel Gregory Hanson

Harvard University - Business School (HBS) ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

Aytek Malkhozov

McGill University ( email )

1001 Sherbrooke St. W
Montreal, Quebec H3A 1G5
Canada

Gyuri Venter (Contact Author)

Warwick Business School ( email )

University of Warwick, Gibbet Hill Road
Coventry, CV4 7AL
United Kingdom

HOME PAGE: http://sites.google.com/site/gyuriventer/

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