Examining swap butterfly risk premia in South Africa

ABSTRACT This paper studies a long butterfly strategy (which is immune to parallel curve shifts but exposed to non-parallel curve shifts) on the South African interest rate swap curve. Ten swap butterfly risk factors are identified using monthly South African swap data from 2001–2022. The top ranked butterfly strategies displayed strong and persistent outperformance over the bottom ranked strategies for each factor, resulting in improved risk-adjusted and absolute returns especially during positive and steep twists, and bull and bear flattening curve scenarios. Trade costs can be significant, so having a pragmatic rebalancing strategy with efficient market makers that limit trade costs to 1bps of spread make these swap butterfly risk factors an effective and successful portable alpha strategy.