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Further, Treasuries (against which swap spreads are computed) are "safe haven" assets whose yields fall during a crisis, so that they trade at a liquidity premium. On this basis, the 30-year swap spread should have increased after the Lehman default. Yet, instead, it declined into negative territory. This authors seek to explain.
In their model, underfunded pension plans' demand for duration hedging leads them to optimally receive the fixed rate in long-maturity swaps. They can balance their asset-liability duration by investing in long-term bonds or by receiving fixed interest via an interest rate swap with long maturity. Authors predict that, if pension funds are underfunded, they prefer to hedge their duration risk with swaps rather than buying Treasuries. The preference for swaps arises because these require only modest investment to cover margins, whereas buying a government bond requires outright investment. Such demand, coupled with dealer balance sheet constraints, results in negative swap spreads. To test their model, they also construct an empirical measure of the aggregate underfunded status of pension plans in Japan, the Netherlands and the United States.
Their evidence suggests that the swap spreads tend to be negative when pension plans are underfunded. Using their measure of the aggregate funding status of US defined benefit (DB) pension plans (both private and public), they test the relationship between the underfunded ratio (UFR) of DB plans and long-term swap spreads in a regression setting. Even after controlling for other common drivers of swap spreads, they find that the UFR is a significant variable in explaining 30-year swap spreads. They also show that swap spreads for shorter maturities are unaffected by changes in the UFR.