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This paper investigates some important determinants of Overnight Indexed Swap (OIS) rates and quantifies them. In tune with the existing studies related to developed countries, this paper is an extension of one of the current challenging and growing money market, i.e. the Indian swap market issues. We use the Vector Autoregressive approach to investigate the determinants of 5-year OIS rate and 1-year OIS rate by using a unique daily data set for a period of October 1999 to August 2010. The result suggests that not only the liquidity is a factor to determine the OIS rate during the recession period, but also the traditional features of the integrated domestic market segments of the emerging economy are also responsible.
Key words: Overnight indexed swap rate, vector autoregression, impulse response function, India
Introduction
Fixed-income derivative market plays an important role in the financial markets. One of its major instruments is the interest rate swap, where fixed are exchanged periodically for floating payments. Because of the immense importance of swap markets in the world economy, a number of studies (Grinblatt, 1995, 2001; Duffie and Singleton, 1997; Lang et al., 1998; He, 2000; Huang and Neftci, 2003; Murphy and Murphy, 2010) tried to define the determinants of swap spread and rate. All the existing studies considered the developed US or European markets (Hamilton, 1996, 1997; Bartolini et al. 2001, 2002; Pérez and Rodríguez, 2003; Würtz, 2003). As in the literature OIS rates has not been analyzed extensively related to any emerging economy, so in this paper we have tried to extend the existing literature by investigating the determinants of overnight indexed swap rates for Indian emerging economy.
The Indian economy is developing with the globalization. The in-depth studies on the sequences of liberalization process can be found in the literature (e.g. Patnaik and Vasudevan, 1999; Jain and Bhanumurthy, 2005). During the nineties, the Indian financial market has undergone many changes. Following the Reserve Bank of India (RBI) guidelines RBI circular (MPD.BC.187/07.01.279/1999-2000 dated July 7, 1999), the derivative products like Interest Rate Swap (IRS) and Forward Rate Agreement (FRA) were incorporated in the Indian money market. Since its inception in 1999, the market for interest rate derivatives in Indian rupee has grown rapidly. The interest rate swap is...