The Term Structure of Interbank Risk

Journal of Financial Economics, vol. 109, no. 4, p. 707-733, 2013

Swiss Finance Institute Research Paper No. 11-34

98 Pages Posted: 8 Sep 2011 Last revised: 11 Feb 2016

Damir Filipović

Ecole Polytechnique Fédérale de Lausanne; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Anders B. Trolle

Ecole Polytechnique Fédérale de Lausanne; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Date Written: October 25, 2012

Abstract

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

Filipović, 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

Damir Filipovic

Ecole Polytechnique Fédérale de Lausanne ( email )

Odyssea
Station 5
Lausanne, 1015
Switzerland

HOME PAGE: http://people.epfl.ch/damir.filipovic

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Anders B. Trolle (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny
Extranef 216
Lausanne, 1015
Switzerland

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

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