Understanding liquidity and credit risks in the financial crisis

Deborah Gefang, Gary Koop, Simon M. Potter

Research output: Contribution to journalArticle

22 Citations (Scopus)

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.
LanguageEnglish
Pages903-914
Number of pages12
JournalJournal of Empirical Finance
Volume18
Early online date3 Aug 2011
DOIs
Publication statusPublished - 2011

Fingerprint

Financial crisis
Liquidity risk
Credit risk
Swap spread
Risk factors
Empirical results
Swaps
Dynamic factor model
Latent factor models

Keywords

  • dynamic factor model
  • LIBOR-OIS spread
  • credit default swap

Cite this

Gefang, Deborah ; Koop, Gary ; Potter, Simon M. / Understanding liquidity and credit risks in the financial crisis. In: Journal of Empirical Finance. 2011 ; Vol. 18. pp. 903-914.
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Understanding liquidity and credit risks in the financial crisis. / Gefang, Deborah; Koop, Gary; Potter, Simon M.

In: Journal of Empirical Finance, Vol. 18, 2011, p. 903-914.

Research output: Contribution to journalArticle

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