Understanding Liquidity and Credit Risks in the Financial Crisis

Deborah Gefang, Gary Koop, Simon M. Potter

Research output: Working paperDiscussion paper

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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.
Original languageEnglish
Place of PublicationGlasgow
PublisherUniversity of Strathclyde
Pages1-26
Number of pages27
Volume11
Publication statusPublished - Oct 2010

Keywords

  • LIBOR
  • OIS
  • LIBOR-OIS spread
  • liquidity risk
  • credit risk

Cite this

Gefang, D., Koop, G., & Potter, S. M. (2010). Understanding Liquidity and Credit Risks in the Financial Crisis. (14 ed.) (pp. 1-26). University of Strathclyde.