AN EMPIRICAL-EXAMINATION OF BASIC VALUATION MODELS FOR PLAIN VANILLA US INTEREST-RATE SWAPS

This paper examines empirical implications of recently developed model s for pricing contracts that swap fixed- for variable-rate interest pa yment streams. Valuation models based on replicating portfolios of con secutive three-month Eurodollar futures contracts that span the life o f the swap perform relatively well, as do pricing models based on repl icating portfolios of noncallable corporate par bonds. Neither set of models, however, is completely empirically consistent with the implica tions of differential counterparty risks. These anomalous results call into question the appropriateness of either the simplifying assumptio ns of the arbitrage-based models or the proxies used for counterparty default risk.