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Can the choice of interpolation method explain the difference between swap prices and futures prices?
Author(s) -
Brown Rob,
Fang Victor
Publication year - 2005
Publication title -
accounting and finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.645
H-Index - 49
eISSN - 1467-629X
pISSN - 0810-5391
DOI - 10.1111/j.1467-629x.2004.00127.x
Subject(s) - futures contract , swap (finance) , interest rate swap , econometrics , interpolation (computer graphics) , economics , variance swap , financial economics , empirical evidence , computer science , volatility swap , finance , implied volatility , volatility (finance) , animation , philosophy , computer graphics (images) , epistemology
The standard model linking the swap rate to the rates in a contemporaneous strip of futures interest rate contracts typically produces biased estimates of the swap rate. Institutional differences usually require some form of interpolation to be employed and may in principle explain this empirical result. Using Australian data, we find evidence consistent with this explanation and show that model performance is greatly improved if an alternative interpolation method is used. In doing so, we also provide the first published Australian evidence on the accuracy of the futures‐based approach to pricing interest rate swaps.