The Term Structure of Interbank Risk

Damir Filipovic and Anders B. Trolle
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Damir Filipovic: Ecole Polytechnique Fédérale de Lausanne and Swiss Finance Institute
Anders B. Trolle: Ecole Polytechnique Fédérale de Lausanne and Swiss Finance Institute

No 11-34, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We use the term structure of spreads between rates on interest rate swaps indexed to LIBOR and overnight indexed swaps to infer a term structure of interbank risk. We develop a dynamic term structure model with default risk in the interbank market that, in conjunction with information from the credit default swap market, allows us to decompose the term structure of interbank risk into default and non-default components. On average, from August 2007 to January 2011, the fraction of total interbank risk due to default risk increases with maturity. At the short end of the term structure, the non-default component is important in the first half of the sample and is correlated with various measures of market-wide liquidity. Further out the term structure, the default component is the dominant driver of interbank risk throughout the sample period. These results hold true in both the USD and EUR markets and are robust to different model parameterizations and measures of interbank default risk. The analysis has implications for monetary and regulatory policy as well as for pricing, hedging, and risk-management in the interest rate swap market.

Keywords: interbank risk; swap market; default risk; liquidity (search for similar items in EconPapers)
JEL-codes: E43 G12 (search for similar items in EconPapers)
Pages: 70 pages
Date: 2011-09
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1134

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