Swap spread: Difference between revisions

Revision as of 12:58, 4 June 2025

Revision as of 12:59, 4 June 2025

Line 33:

==Negative swap spreads==

Negative swap spreads are a new phenomenon occurring in the market. Beginning in 2008 the commonly referenced swap spread on the 30-year swap T-bonds turned negative and has remained so since. The swap spread on the 10 year T-bonds also turned negative during 2015 in response to the Chinese government selling US treasuries. Negative swap spreads are difficult for traditional asset pricing models to utilise as they imply a risk free arbitrage opportunity <ref name=J />. The development of the financial markets has propelled market efficiency and during a limited arbitrage environment negative swap spreads are not uncommon. Therefore negative swap spreads are indicative of market development and efficiency. A negative swap spread also is an indicator of a market arbitrage opportunity however in order to capitalise on this opportunity market participants must assume exposure to the repo market. (Refinitive<ref Perspectivesname= 2021)Refini /> For market participants broadly, those who do not undertake a market arbitrage strategy an inversion in swap spreads suggests that overall market upside is limited. Upside however resumed once the swap spread normalises. (Sclip,<ref Girardone,name= C.,Refini & Miani, S. (2019)./>

Swap Spread as an economic indicator

Given that swap spreads require an understanding of basic arithmetic they have been labelled as complex financial products which quantify the difference between yields in on government bonds and interest rate swaps on similar securities. During periods of sustained economic volatility swap spread markets move violently as financial institutions slash rates to contain economic fallout. Spreads widen, volumes surge and prices fluctuate substantially during periods of economic stress evdent in the 2008 GFC and Covid 19 economic meltdown in March 2020. (Amir Khwaja 2020)