What determines the yen swap spread?

•Credit spreads on Japanese yen bonds and interest rate swaps are investigated.•Yen swap spreads contain risks other than default and liquidity risks.•These include pro-cyclical and counter-cyclical elements of business cycle risk.•Others include skewness and correlation risk (between fixed and floating rates).

We investigate if Japanese yen denominated interest rate swap spreads price risks in addition to liquidity and default risk. These additional risks include: the time-varying correlation between interest rates of different types and maturities; business cycle risk; and market skewness risk. Our analysis, over a number of different maturities and sample periods, supports the existence of an additional risk premium. We also show that the time-varying correlation between short term market interest rates (e.g., TIBOR) and the longer term Government bond yield (e.g., Gensaki) is of particular importance. Japanese yen swap spreads are shown to contain both pro-cyclical and counter-cyclical elements of business cycle risk, positive risk premia for skewness risk and variable risk premia for correlation risk (between fixed and floating interest rates).