The market for sharing interest rate risk: quantities behind prices

Umang Khetan (), Ioana Neamțu () and Ishita Sen ()
Additional contact information
Umang Khetan: University of Iowa
Ioana Neamțu: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Ishita Sen: Harvard Business School

No 1031, Bank of England working papers from Bank of England

Abstract: We study the extent of interest rate risk sharing across the financial system. We use granular positions and transactions data in interest rate swaps, covering over 60% of overall swap activity in the world. We show that pension and insurance (PF&I) sector emerges as a natural counterparty to banks and corporations: overall, and in response to decline in rates, PF&I buy duration, whereas banks and corporations sell duration. This cross-sector netting reduces the aggregate net demand that is supplied by dealers. However, two factors impede cross-sector netting and add to dealer imbalances across maturities. (i) PF&I, bank and corporate demand is segmented across maturities. (ii) Large volumes are traded by hedge funds, who behave like banks in the short end and like PF&I in the long end. This worsens segmentation, exposing dealers to a steepening or flattening of the yield curve in addition to residual duration risk. Consistent with this, we find that demand pressure, in particular hedge funds’ trades, impact swap spreads across maturities. We also document that long-tenor pension fund trades are less likely to be centrally cleared, adding counterparty credit risk to demand imbalances.

Keywords: Interest rate risk; OTC derivatives; hedge funds; pension funds; insurance companies; banks; non-financial corporations; demand elasticities; counterparty credit risk (search for similar items in EconPapers)
JEL-codes: G11 G12 G15 G21 G22 G23 G24 G32 (search for similar items in EconPapers)
Pages: 62 pages
Date: 2023-07-21
New Economics Papers: this item is included in nep-cfn, nep-ger, nep-ifn and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
https://www.bankofengland.co.uk/-/media/boe/files/ ... es-behind-prices.pdf Full text (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:1031

Access Statistics for this paper

More papers in Bank of England working papers from Bank of England Bank of England, Threadneedle Street, London, EC2R 8AH. Contact information at EDIRC.
Bibliographic data for series maintained by Digital Media Team ().