Components of the bid-offer rates in Yen-Dollar currency swap market: an empirical investigation

Abstract

The instability of exchange rates in the late 1970s and early 1980s initiated the process of financial innovations in international financial markets. Among the new hedging instruments, currency swaps have been the most striking product Although much has been written about the mechanics of the swap market, the major influences on the level and the direction of swap spreads have not been fully analyzed Some research appeared on the empirical aspects of the swap market, but was restricted to interest rate swaps only. Using biweekly yen-dollar swap quotations for the period between October 1987 to June 1998, this study provides some stylized facts about the behavior of the swap rates in the cross-currency and currency interest swap market An analysis of the bid-offer rates shows that the spread between the bid and offer rates is low. We test the empirical implications of modeling currency swaps as an exchange of two hypothetical bonds. We find that yen-dollar exchange rate, the yen discount rate, and the Treasury rate of equivalent maturity are statistically significant in explaining the all-in swap bid-rate in the yen-dollar currency swap market.