Determinants of interest rate swap spreads in the US: bounds testing approach to cointegration

Abstract

This article empirically analyses the determinants of US interest rate swap spreads, and makes two key contributions. First, it considers the nonstationarity of time series, which previous studies have not done, and conducts a cointegration test using the bounds testing approach. The empirical results reveal that there exists a cointegration relationship between interest rate swap spreads and four determinants: the corporate bond spread, the slope of the yield curve, the T bill and Eurodollar (TED) spread and yield volatility. Second, it analyses the determinants of swap spreads using the Dynamic Ordinary Least Squares (DOLS). Considering the cointegration relationship, all explanatory variables were significant within the 5% level.

Keywords:

• swap spread
• bounds testing approach
• cointegration
• dynamic OLS

JEL Classification::

• E43
• G19

Acknowledgements

I thank an anonymous referee and the editor, Mark Taylor, for useful comments. All remaining errors are my own.

Notes

¹ See Nelson (1991) for the EGARCH model.

² See Dickey and Fuller (1979) for the ADF test.

³ See Schwarz (1978) as for SBIC.