Interest Rate Swaps and Corporate Default

Abstract

This paper studies firms’ usage of interest rate swaps to manage risk in a model economy driven by aggregate productivity shocks, inflation shocks, and counter-cyclical idiosyncratic productivity risk. Consistent with empirical evidence, firms in the model are fixed-rate payers, and swap positions are negatively correlated with the term spread. In the model, swaps affect firms’ investment decisions and debt pricing only very moderately, and the availability of swaps generates only small economic gains for the typical firm.

Keywords: Interest Rate Swaps, Corporate Default, Risk Management, Swap Position, Debt Pricing

JEL Classification: E44, G12