Modeling Chilean Long-Term Swap Yields Based on the Short-Term Interest Rate: A Garch Approach

This paper models the dynamics of Chilean interest rate swap yields. It examines whether the change in the short-term interest rate exerts a decisive influence on the change in long-term swap yields after controlling key macroeconomic and financial variables, such as inflation, the growth in industrial production, the percentage change in the equity price index and the percentage change in the exchange rate of the Chilean peso (CLP). It applies the generalized autoregressive conditional heteroskedasticity (GARCH) approach to econometrically model the dynamics of the long-term swap yield to mitigate the variation in volatility exhibited in the financial markets. The results of the estimated GARCH models show that the change in the short-term interest rate has an economically and statistically significant effect on the change in the swap yield after controlling for key macroeconomic and financial factors. These findings imply that the monetary policy of the country’s central bank, the Banco Central de Chile (BCCH), has an important influence on swap yields in Chile through its effect on the short-term interest rate.