Low-Frequency Volatility of Yen Interest Rate Swap Market in Relation to Macroeconomic Risk


  • *We thank an anonymous referee of International Review of Finance for insightful comments and suggestions, which increased the value of this paper. A special thank to Jose Gonzalo Rangel for sharing his computer program of Spline-GARCH model. The first author is thankful to MRGS (Monash Research Graduate School, Monash University) for financial support toward his doctoral study at Monash. All remaining errors are our responsibility.

A.S.M. Sohel Azad
Department of Accounting and Finance
Monash University
Caulfield East, Victoria 3145, Australia
Sohel.Azad@monash.edu or asmsohelazad@gmail.com


Using ‘low-frequency’ volatility extracted from aggregate volatility shocks in interest rate swap (hereafter, IRS) market, this paper investigates whether Japanese yen IRS volatility can be explained by macroeconomic risks. The analysis suggests that this low-frequency yen IRS volatility has strong and positive association with most of the macroeconomic risk proxies (e.g., volatility of consumer price index, industrial production volatility, foreign exchange volatility, slope of the term structure and money supply) with the exception of the unemployment rate, which is negatively related to IRS volatility. This finding is fairly consistent with the argument that the greater the macroeconomic risk the greater is the use of derivative instruments to hedge or speculate. The relationship between the macroeconomic risks and IRS volatility varies slightly across the different swap maturities but is robust to alternative volatility specifications. This linkage between swap market and macroeconomy has practical implications since market makers and hedgers use the swap rate as benchmark for pricing long-term interest rates, corporate bonds and various other securities.