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Modeling Swap Spreads in Normal and Stressed Environments

Vineer Bhansali, Yonathan Schwarzkopf and Mark B Wise
The Journal of Fixed Income Spring 2009, 18 (4) 5-23; DOI: https://doi.org/10.3905/JFI.2009.18.4.005
Vineer Bhansali
is a managing director at PIMCO in Newport Beach, CA.
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  • For correspondence: bhansali@pimco.com
Yonathan Schwarzkopf
is a PIMCO graduate fellow at California Institute of Technology in Pasadena, CA and graduate fellow at Santa Fe Institute in Santa Fe, NM.
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  • For correspondence: yoni@theory.caltech.edu
Mark B Wise
is a professor at California Institute of Technology in Pasadena, CA.
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  • For correspondence: wise@theory.caltech.edu
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Abstract

We develop a simple integrated model for the term structure of swap spreads. We begin with a model that explains the dynamics of the riskless treasury curve in terms of two factors. We add to the basic model additional inputs that describe the evolution of the implied hazard rate intensity for interest rate swaps. Based on the model, we derive closed form expressions for observables such as the shape of the term structure of swap spreads and the term structure of volatilities. Our model is economically motivated, and is appealing in its simplicity and robustness in being able to explain the dynamics of the swap spread term structure in both normal and stressed markets. We apply the technique to swap-spread term structures for various international markets.

TOPICS: Factor-based models, interest-rate and currency swaps, volatility measures, developed markets [US, UK, Japan]

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The Journal of Fixed Income
Vol. 18, Issue 4
Spring 2009
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Modeling Swap Spreads in Normal and Stressed Environments
Vineer Bhansali, Yonathan Schwarzkopf, Mark B Wise
The Journal of Fixed Income Mar 2009, 18 (4) 5-23; DOI: 10.3905/JFI.2009.18.4.005

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Modeling Swap Spreads in Normal and Stressed Environments
Vineer Bhansali, Yonathan Schwarzkopf, Mark B Wise
The Journal of Fixed Income Mar 2009, 18 (4) 5-23; DOI: 10.3905/JFI.2009.18.4.005
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  • Article
    • Abstract
    • TERM STRUCTURE MODEL
    • HAZARD RATE MODEL FOR SWAP SPREADS
    • FITTING THE MODEL TO EMPIRICAL DATA
    • CONCLUSIONS
    • APPENDIX A
    • APPENDIX B
    • APPENDIX C
    • ENDNOTES
    • REFERENCES
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