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<p id="isPasted">In the aggregate, supply and demand factors take over. Swap spreads are essentially an indicator of the desire to hedge risk, the cost of that hedge, and the overall liquidity of the market.</p><p>The more people who want to swap out of their risk exposures, the more they must be willing to pay to induce others to accept that risk. Therefore, larger swap spreads mean there is a higher general level of risk aversion in the marketplace. It is also a gauge of systemic risk. When there is a swell of desire to reduce risk, spreads widen excessively. It is …</p>
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<p><br>Swap spreads correlate closely with credit spreads as they reflect the perceived risk that swap counterparties will fail to make their payments. Swap spreads are used by large corporations and governments to fund their operations. Typically, private entities pay more or have positive swap spreads as compared to the US government.</p>
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<p id="isPasted">Just to spell out the problem - I presume you mean why overnight swap rates are used instead of treasury bond yield curves for valuations.</p><p>In the order of riskiness, overnight swap rates are very close to being risk free. So they can technically be used as a close proxy for a risk free rate (such as the treasury yield curves).</p><p>In some of the markets such as India, treasury bonds carry certain caveats that are usually not discussed in detail in text books. There are issues such as sovereign risk, central bank intervention and the 'freeness' of the market …</p>
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