The Term Structure of Interbank Risk

We infer a term structure of interbank risk from spreads between rates on interest rate swaps indexed to the London Interbank Offered Rate (LIBOR) and overnight indexed swaps. We develop a tractable model of interbank risk to decompose the term structure into default and non-default (liquidity) components. From August 2007 to January 2011, the fraction of total interbank risk due to default risk, on average, increases with maturity. At short maturities, the non-default component is important in the first half of the sample period and is correlated with measures of funding and market liquidity. The model also provides a framework for pricing, hedging, and risk management of interest rate swaps in the presence of significant basis risk.

Keywords: Interbank risk, LIBOR, Swap market, Default risk, Liquidity

JEL Classification: E43, G01, G12

Suggested Citation: Suggested Citation

Filipovic, Damir and Trolle, Anders B., The Term Structure of Interbank Risk (October 25, 2012). Journal of Financial Economics, vol. 109, no. 4, p. 707-733, 2013, Swiss Finance Institute Research Paper No. 11-34, Available at SSRN: https://ssrn.com/abstract=1923696 or http://dx.doi.org/10.2139/ssrn.1923696