Decomposing Swap Spreads

58 Pages Posted: 22 Mar 2005

See all articles by Peter Feldhütter

Peter Feldhütter

Copenhagen Business School

David Lando

Copenhagen Business School

Date Written: May 3, 2007

Abstract

We analyze a six-factor model for Treasury bonds, corporate bonds, and swap rates and decompose swap spreads into three components: A convenience yield from holding Treasuries, a credit risk element from the underlying LIBOR rate, and a factor specific to the swap market. The convenience yield is by far the largest component of spreads, there is a discernible but not highly variable contribution from credit risk, and a swap-specific factor with higher variability which in periods is related to hedging activity in the MBS market. The model further sheds light on the relationship between AA hazard rates and the spread between LIBOR rates and GC repo rates and on the level of the riskless rate compared to swap and Treasury rates.

Keywords: Swap spreads, corporate bond spreads, term structure of interest rates

JEL Classification: E43, G12, G13

Suggested Citation

Feldhütter, Peter and Lando, David, Decomposing Swap Spreads (May 3, 2007). EFA 2006 Zurich Meetings, Available at SSRN: https://ssrn.com/abstract=687378 or http://dx.doi.org/10.2139/ssrn.687378

Peter Feldhütter

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

David Lando (Contact Author)

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark
+45 3815 3600 (Fax)

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