European Asset Swap Spreads and the Credit Crisis

Research Aim

Asset swap (ASW) spreads are bond specific measures of credit risk implied in bond prices. They are based on a synthetic position that combines a fixed rate bond with a fixed-to-floating interest rate swap and are, therefore, available for every firm that has issued a bond. This is a big advantage to credit default swaps (CDS) which are typically only available for a view very big companies. Our objective is twofold. First, we examine determinants of ASW spreads for the first time in the literature. Second, we examine the time-varying nature of the association of ASW spreads and their economic determinants.


The leptokurtic distribution of our sample ASW spreads together with time-varying properties of the parameters call for consideration of non-linearity and regime shifts. Markov models provide an intuitive way to model structural breaks and regime shifts in the data generating process.

Practical implications

Our regime-switching model provides estimates that match well with economic events during the recent crisis. The documented regime specific dynamics of ASW spreads is important for participants in the bond market, both for valuation and hedging purposes. For efficient hedging of credit risk market participants should take into account differences between relevant market regimes and industry sectors. The regime shifts may also be important for investors in exchange traded funds (ETFs) tracking bond indexes.