Understanding liquidity and credit risks in the financial crisis

Deborah Gefang, Gary Koop and Simon Potter

Journal of Empirical Finance, 2011, vol. 18, issue 5, 903-914

Abstract: This paper develops a structured dynamic factor model for the spreads between London Interbank Offered Rate (LIBOR) and overnight index swap (OIS) rates for a panel of banks. Our model involves latent factors which reflect liquidity and credit risk. Our empirical results show that surges in the short term LIBOR-OIS spreads during the 2007–2009 financial crisis were largely driven by liquidity risk. However, credit risk played a more significant role in the longer term (twelve-month) LIBOR-OIS spread. The liquidity risk factors are more volatile than the credit risk factor. Most of the familiar events in the financial crisis are linked more to movements in liquidity risk than credit risk.

Keywords: Dynamic factor model; LIBOR-OIS spread; Credit default swap (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (33)

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Related works:
Working Paper: Understanding Liquidity and Credit Risks in the Financial Crisis (2011)
Working Paper: Understanding Liquidity and Credit Risks in the Financial Crisis (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:18:y:2011:i:5:p:903-914

DOI: 10.1016/j.jempfin.2011.07.006

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