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Low‐Frequency Volatility of Yen Interest Rate Swap Market in Relation to Macroeconomic Risk *
Author(s) -
SOHEL AZAD A.S.M.,
FANG VICTOR,
WICKRAMANAYAKE J.
Publication year - 2011
Publication title -
international review of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.489
H-Index - 18
eISSN - 1468-2443
pISSN - 1369-412X
DOI - 10.1111/j.1468-2443.2011.01129.x
Subject(s) - volatility swap , volatility (finance) , economics , variance swap , volatility risk premium , volatility smile , interest rate swap , implied volatility , volatility risk , forward volatility , swap (finance) , monetary economics , interest rate , econometrics , financial economics , finance
Using ‘low‐frequency’ volatility extracted from aggregate volatility shocks in interest rate swap (hereafter, IRS) market, this paper investigates whether Japanese yen IRS volatility can be explained by macroeconomic risks . The analysis suggests that this low‐frequency yen IRS volatility has strong and positive association with most of the macroeconomic risk proxies (e.g., volatility of consumer price index, industrial production volatility, foreign exchange volatility, slope of the term structure and money supply) with the exception of the unemployment rate, which is negatively related to IRS volatility. This finding is fairly consistent with the argument that the greater the macroeconomic risk the greater is the use of derivative instruments to hedge or speculate. The relationship between the macroeconomic risks and IRS volatility varies slightly across the different swap maturities but is robust to alternative volatility specifications. This linkage between swap market and macroeconomy has practical implications since market makers and hedgers use the swap rate as benchmark for pricing long‐term interest rates, corporate bonds and various other securities.