Determination of the impact factors for the 3s6s Basis Swap

Nils Henrik Naumann

Student thesis: Master thesis

Abstract

The objective of the thesis was to determine the main drivers of the 3s6s Basis swap spread between 01/01/2007 and 01/11/2011. The 3s6s Basis swap spread is calculated as the di erence by which the 6 month Euribor rate trades above the compounded 3 month Euribor and 3 month forward rate starting in 3 months, the 3X6 forward rate agreement. The di erence re ects a term premium for providing liquidity over a longer period. A multiple linear regression model has been applied to test the drivers of the 3s6s Basis swap. As it turns out in the time surrounding the default of Lehman Brothers the main drivers have been the independent variables representing the credit risk. The impact of the liquidity risk has been increasing over time after the default in September 2008. A Granger causality test has been applied to test predictive relationships between the 3s6s Basis swap spread and a volatility index. The two time series have a feedback relationship. An extended autoregressive distributed lag model has been applied to check for predictive relationship. The variables included are stock returns, according to the three-factor model by Fama and French, interest-rate returns, as used by Fama and French, as well as a volatility index. The results show that the 3s6s Basis swap spread helps to predict stock returns and movements in the volatility index. Furthermore, the volatility index has a negative e ect on the stock returns. For interest-rate returns, however, the only signi cant variable is its own past lag. A vector autoregression model has been run in order to check for impulse response functions and the correlation between the following variables: 3s6s Basis swap spread, stock returns and a volatility index. The results show a negative relationship between stock returns and the 3s6s Basis swap spread and a positive one between the volatility index and the 3s6s Basis swap spread. Finally an amendment to the way interest-rate derivatives are priced has been presented in order to outline the consequences of the 3s6s Basis swap spread which is the result from the nancial crisis starting in August 2007.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2012
Number of pages75