This paper produces evidence in support of the existence of common risk factors in the US and
UK interest rate swap markets. Using a multivariate smooth transition autoregression (STVAR)
framework, we show that the dynamics of the US and UK swap spreads are best described by a
regime-switching model. We identify the existence of two distinct regimes in US and UK swap
spreads; one characterized by a "flat" term structure of US interest rates and the other
characterized by an "upward" slopping US term structure. In addition, we show that there exist
significant asymmetries on the impact of the common risk factors on the US and UK swap
spreads. Shocks to UK oriented risk factors have a strong effect on the US swap markets during
the "flat" slope regime but a very limited effect otherwise. On the other hand, US risk factors
have a significant impact on the UK swap markets in both regimes. Despite their added
flexibility, the STVAR models do not consistently produce superior forecasts compared to less
sophisticated autoregressive (AR) and vector autoregressive (VAR) models