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Negative Swap Spreads and Limited Arbitrage

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  • Urban Jermann

Abstract

Since October 2008 fixed rates for interest rate swaps with a thirty year maturity have been mostly below treasury rates with the same maturity. Under standard assumptions this implies the existence of arbitrage opportunities. This paper presents a model for pricing interest rate swaps where frictions for holding bonds limit arbitrage. I show analytically that negative swap spreads should not be surprising. In the calibrated model, swap spreads can reasonably match empirical counterparts without the need for large demand imbalances in the swap market. Empirical evidence is consistent with the relation between term spreads and swap spreads in the model

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  • Urban Jermann, 2019. "Negative Swap Spreads and Limited Arbitrage," NBER Working Papers 25422, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:25422
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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