Abstract

We estimate a model of the term-structure of the basis swap following Diebold, Rudebusch and Aruoba (2005). The original model was developed to summarize the yield curve using latent factors (specifically, level, slope and curvature) and also include observable macroeconomic variables. We apply this model to analysis on the basis swap and to link it with the macroeconomic factors (such as interest rate differentials, credit risk and liquidity indicators). Our goal is to provide a characterization of the recent deviation from the covered interest parity (CIP) and to link it to the macroeconomic variables. We also relate our results to the foreign exchange rate forecasts.