Determinants Of Interest Rate Swap Spread: An Analysis Of Chinese Market

Based on the data of FR0071-year,3-year and 5-year interest rate swaps and treasury bond yield of the same maturities of Chinese market, with stepwise multiple linear regression, I choose 4 important factors which may play key roles in swap spread determination. The 4 factors are:inflation rate,7-day repo rate, the slope of the interest rate term structure, and the volatility of short term interest rate. After careful analysis of Chinese market, I select the proxy variables of the 4 factors as follows: month-on-month growth rate of CPI, monthly average of R.007,1-year treasury bond rate, and the difference of 10-year bond rate and 1-year bond rate. After conducting multiple linear regression, I use the VAR model to analyze the data, compute the impulse function and do the variance decomposition.The results of this thesis are as follows:except for the swap spread itself, the factor which affects it most is the slope of the interest rate term structure. When the slope steepens, the swap spread will widen, but the variance contribution of the slope becomes smaller when the maturity gets longer; as the reference rate of the floating rate of interest rate swaps,7-day repo rate has very strong positive impact on the swap spread too; when the rate of inflation increases, swap spread narrows. This may because of that bond rate is more sensitive to the change of inflation rate; besides, the volatility of short term interest rate will also have negative impact on swap spread.