Determinants of New Taiwan Dollar Interest Rate Swap Spreads

Abstract

This study examines the determinants of New Taiwan Dollar interest rate swap (NTD IRS) spreads. Prior literature provides evidence that the term structure of interest rates, liquidity, and credit risk comprise the swap spreads. The term structure of interest rates includes the interest rate level, the slope of the yield curve, and the interest rate volatility. The empirical results for the full sample period show that the interest rate level, the slope of the yield curve, interest rate volatility, liquidity risk, and credit risk are all important factors affecting the swap spreads. Results of the variance decomposition for the full sample period indicate that default risk is the most important factor among the five components. Furthermore, the results show that the explanatory power of the regression model for the term structure of interest rates, liquidity, and credit risk is higher in a bear market than in a bull market. Finally, the results of variance decomposition indicate that default risk plays a more important role than other factors in a bear market, but the key factor varies with the maturities of swap contracts in a bull market.

Keywords: Swap spreads, Term structure of interest rates, Liquidity risk, Credit risk, Market conditions

JEL Classification: G10, G15