Abstract
Swap spreads are vital in forecasting risk-free or benchmark interest rates, such as swap rates. They also play a significant role in the economy by gauging market sentiment, liquidity and credit conditions and therefore informing the decisions of central banks, commercial banks, institutional investors and corporates. Historically, swap spreads have been positive. However, negative swap spreads have become prevalent in many countries after the 2007-2008 global financial crisis and the implementation of more stringent global banking regulations. Amongst others, this experience challenges the validity of debt pricing or valuation models that are based on the assumption that swap spreads are positive and stable. Globally, there exists limited literature focussing on the forecasting and modelling of swap spreads in the post-2008 environment. This study aims to identify the financial variables that explain South African swap spreads across different maturities in this new environment. This is a first attempt to investigate the impact of banks’ more stringent regulatory capital requirements and the impact of the interest differential between South Africa and larger swap markets, like the United States, on South African swap spreads. Three VAR models for the 2-, 10- and 30-year swap spread maturities were estimated and supplemented by: the Granger causality test, the impulse response function, and the forecast error variance decomposition function. The liquidity premium was found to have a limited impact on all South African swap spreads. The interest rate differential relative to US rates was the most significant determinant for the 2-year and 10-year swap spreads, while the slope of the government bond yield curve was the most significant determinant for the 30-year swap spreads. Furthermore, the capital requirements of banks were found to be significant determinants for the 10-year and 30-year swap spreads.