Liquidity risk contagion in the interbank market

Andrea Eross (), Andrew Urquhart and Simon Wolfe

Journal of International Financial Markets, Institutions and Money, 2016, vol. 45, issue C, 142-155

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.

Keywords: Contagion; Financial crises; Interbank market; Liquidity shocks; Structural breaks (search for similar items in EconPapers)
JEL-codes: C32 G15 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:45:y:2016:i:c:p:142-155

DOI: 10.1016/j.intfin.2016.07.005

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