Tail Risk Killers: How Math, Indeterminacy, and Hubris Distort Markets

CHAPTER 32The Information Content of a Negative Swap Spread: Hedge Funds Turn Down Free Money

The interest-rate swap market is freaking huge and somewhat new (the first interest-rate swap was in 1981 between the World Bank and IBM¹). The instrument itself is a weird animal in that its value derives from an offer rate and a bond yield, not an underlying asset. In this sense, interest-rate swaps are more like an asset (bondish) than a derivative. The most elemental parts of the economy—government debt and interbank markets—converge in interest-rate swaps.

Because the market is so big and used in so many different ways, swap spreads and swap volume are now arguably a central lynchpin of the interbank mechanism. In fact, swap curves are the benchmark ...