Liquidity risk contagion in the interbank market
Liquidity risk contagion in the interbank market
This paper studies liquidity risk contagion within the interbank market by assessing the long-run relationship of short-term interest rate spreads from January 2002 to December 2015. In particular, we model the interaction between the LIBOR–OIS spread, euro fixed-float OIS swap rate and the three-month US-German bond spread and discover strong evidence of structural innovations affecting the interbank market. We find that when the short-term interbank market is affected by a liquidity shock, the LIBOR–OIS spread is a leader in moving back to equilibrium, while the euro-dollar currency swap rate and the US-German bond spreads are followers. Moreover, we find long-run cointegrating relationships and bi-directional causality between the spreads. However, structural breaks identified as prospective financial crises affect the long-run relationships and liquidity shocks drive interbank rates and spread fluctuations. Therefore, liquidity shocks propagating within the interbank market can forecast benchmark interest movements, and ultimately this has significant implications for policy-makers and market players alike.
142-155
Eross, Andrea
7f124036-c1f2-402f-83c0-717b74753988
Urquhart, Andrew
ee369df1-95b5-4cdf-bc24-f1be77357c03
Wolfe, Simon
9a2367fc-36cc-496a-bbd2-e7346bcbb19e
November 2016
Eross, Andrea
7f124036-c1f2-402f-83c0-717b74753988
Urquhart, Andrew
ee369df1-95b5-4cdf-bc24-f1be77357c03
Wolfe, Simon
9a2367fc-36cc-496a-bbd2-e7346bcbb19e
Eross, Andrea, Urquhart, Andrew and Wolfe, Simon
(2016)
Liquidity risk contagion in the interbank market.
Journal of International Financial Markets, Institutions and Money, 45, .
(doi:10.1016/j.intfin.2016.07.005).
Abstract
This paper studies liquidity risk contagion within the interbank market by assessing the long-run relationship of short-term interest rate spreads from January 2002 to December 2015. In particular, we model the interaction between the LIBOR–OIS spread, euro fixed-float OIS swap rate and the three-month US-German bond spread and discover strong evidence of structural innovations affecting the interbank market. We find that when the short-term interbank market is affected by a liquidity shock, the LIBOR–OIS spread is a leader in moving back to equilibrium, while the euro-dollar currency swap rate and the US-German bond spreads are followers. Moreover, we find long-run cointegrating relationships and bi-directional causality between the spreads. However, structural breaks identified as prospective financial crises affect the long-run relationships and liquidity shocks drive interbank rates and spread fluctuations. Therefore, liquidity shocks propagating within the interbank market can forecast benchmark interest movements, and ultimately this has significant implications for policy-makers and market players alike.
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Accepted/In Press date: 5 July 2016
e-pub ahead of print date: 15 July 2016
Published date: November 2016
Organisations:
Centre of Excellence for International Banking, Finance & Accounting
Identifiers
Local EPrints ID: 397750
URI: http://eprints.soton.ac.uk/id/eprint/397750
ISSN: 1042-4431
PURE UUID: 4c5a0208-88e7-43a7-abd1-a6713cdcec9a
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Date deposited: 06 Jul 2016 10:10
Last modified: 15 Mar 2024 05:43
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Author:
Andrea Eross
Author:
Andrew Urquhart
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