Interest Rate Swaps and Corporate Financing Choices



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    • Graduate School of Management, University of California, Los Angeles. This paper has benefited from helpful comments and discussions with Michael Brennan, Bhagwan Chowdhry, Leland Crabbe, Kent Daniel, Mark Grinblatt, David Hirshleifer, Steve Kaplan, James Seward, and Ivo Welch. I also wish to thank seminar participants at the Federal Reserve Board of Governors, INSEAD, the London Business School, the University of British Columbia, the University of Colorado, the University of Georgia, Northwestern University, and the University of Texas.


This paper describes the firm's decision to borrow short-term versus long-term and shows how the introduction of interest rate swaps affects this choice. The model shows that in the absence of a swap market, interest rate uncertainty can lead firms to substitute long-term for short-term financing. However, when swaps exist, there is a tendency for firms that expect their credit quality to improve to borrow short-term and use swaps to hedge interest rate risk. The model suggests that, while the demand for fixed for floating swaps is enhanced, the demand for floating for fixed swaps is reduced by the presence of asymmetric information.