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Common risk factors in the U.S. and UK interest rate swap markets: Evidence from a nonlinear vector autoregression approach
Author(s) -
Lekkos Ilias,
Milas Costas
Publication year - 2004
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.10116
Subject(s) - swap (finance) , interest rate swap , vector autoregression , econometrics , economics , financial economics , interest rate , monetary economics , finance
This paper produces evidence in support of the existence of common risk factors in the U.S. and UK interestrate swap markets. Using a multivariate smooth transition autoregression (STVAR) framework, we showthat the dynamics of the U.S. and UK swap spreads are best described by a regime‐switching model. Weidentify the existence of two distinct regimes in U.S. and UK swap spreads; one is characterized by a“flat” term structure of U.S. interest rates and the other is characterized by an“upward” sloping U.S. term structure. In addition, we show that there exist significant asymmetrieson the impact of the common risk factors on the U.S. and UK swap spreads. Shocks to UK oriented risk factorshave a strong effect on the U.S. swap markets during the “flat” slope regime but a very limitedeffect otherwise. On the other hand, U.S. risk factors have a significant impact on the UK swap markets in bothregimes. © 2004 Wiley Periodicals, Inc. Jrl Fut Mark 24:221–250, 2004