Demand-and-supply imbalance risk and long-term swap spreads

Samuel G. Hanson, Aytek Malkhozov and Gyuri Venter

Journal of Financial Economics, 2024, vol. 154, issue C

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 (search for similar items in EconPapers)
JEL-codes: E43 G12 (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:154:y:2024:i:c:s0304405x24000370

DOI: 10.1016/j.jfineco.2024.103814

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