An Explanation of Negative Swap Spreads:

Demand for Duration from Underfunded Pension Plans

with Suresh Sundaresan
Journal of Finance, Volume 72 (2) (2019), pages 675-710

Winner of the SFI outstanding paper award 2016


Abstract: The 30-year U.S. swap spreads have been negative since September 2008. We offer a novel explanation for this persistent anomaly. Through an illustrative model, we show that underfunded pension plans optimally use swaps for duration hedging. Combined with dealer banks' balance sheet constraints, this demand can drive swap spreads to become negative. Empirically, we construct a measure of the aggregate funding status of Defined Benefit pension plans and show that this measure is a significant explanatory variable of 30-year swap spreads. We find a similar link between pension funds' underfunding and swap spreads for two other regions.

Safe Haven CDS Premiums

with David Lando

Review of Financial Studies, Volume 31 (5) (2018), pages 1856-1895


Abstract: We develop a model in which a derivatives-dealing bank faces capital charges from uncollateralized swap positions with sovereigns, and buys Credit Default Swap (CDS) contracts to obtain capital relief. CDS premiums depend on margin requirements for buyers and sellers of CDS contracts, the value of capital relief for the dealer banks, and the return on a risky asset. We explain the regulatory requirements that lead derivatives dealers to buy CDS and translate volumes of derivatives contracts outstanding between sovereigns and banks into CDS hedging demand. We argue that CDS premiums for safe sovereigns are primarily driven by regulatory requirements.

Article based on my master thesis:

Option Pricing with Time-Changed Levy Processes

with Y. S. Kim, S. T. Rachev, and F. J. Fabozzi

Applied Financial Economics, 2013, 23(15) p. 1231-1238


Abstract: In this article, we introduce two new six-parameter processes based on time-changing tempered stable distributions and develop an option pricing model based on these processes. This model provides a good fit to observed option prices. To demonstrate the advantages of the new processes, we conduct two empirical studies to compare their performance to other processes that have been used in the literature.

Working Papers

High Funding Risk, Low Return

New Version

Abstract: Guided by a simple model in which hedge fund managers with access to less-profitable investment strategies take more funding risk, I show that funds with a high exposure to market-wide funding shocks - measured by changes in Libor-OIS spreads - subsequently underperform funds with a low exposure to market-wide funding shocks by 5.99\% annually on a risk-adjusted basis (t=3.53). In line with my theory, the performance difference between low-funding-risk and high-funding-risk funds is largest and most significant when funding constraints are most binding and for funds with higher unwinding costs.

Burying Libor

with Olav Syrstad

Norges Bank Working Paper

Abstract: We argue that the planned transition toward alternative benchmark rates gives reason to mourn Libor. Guided by a model in which banks and non-banks can lend to each other, subject to realistic regulatory constraints, we show empirically that tighter financial regulation increases interbank rates but lowers broad rates (in which lenders are non-banks) and that all market rates increase with more Treasury bill issuance. Hence, the proportion of non-bank lenders affects the alternative rates, introducing variation in the benchmark that is unrelated to banks' marginal funding costs and creating a basis between regions with interbank rates and broad rates.

Active Loan Trading

with Frank Fabozzi, Pia Mølgaard, Mads Stenbo Nielsen

Revise & Resubmit: Journal of Financial Intermediation


Abstract: Analyzing a novel dataset of leveraged loan trades executed by managers of collateralized loan obligations (CLOs), we document the importance of "active loan trades" -- trades executed at a manager's discretion. Active loan sales are conducted at better prices than non-active sales and before rating downgrades. More active CLOs trade at better prices than less active CLOs, selling leveraged loans earlier and before they get downgraded. More active trading also increases the returns to equity investors and lowers collateral portfolio default rates. In contrast, tests with a placebo variable, capturing passive turnover, lead to insignificant results.





Department of Finance
BI Oslo

Nydalsveien 37

NO - 0442 Oslo


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