Liquidity Risk, Credit Risk and the Overnight Interest Rate Spread: A Stochastic Volatility Modelling Approach

16 Pages Posted: 12 Oct 2013

See all articles by John Beirne

John Beirne

European Central Bank (ECB)

Guglielmo Maria Caporale

Brunel University London - Department of Economics and Finance; London South Bank University; CESifo (Center for Economic Studies and Ifo Institute); German Institute for Economic Research (DIW Berlin)

Nicola Spagnolo

Brunel University London - Economics and Finance

Multiple version iconThere are 3 versions of this paper

Date Written: December 2013

Abstract

In this paper we model the volatility of the spread between the overnight interest rate and the central bank policy rate (the policy spread) for the euro area and the UK during the two main phases of the financial crisis that began in late 2007. We find a strong role played by liquidity risk volatility, but also private bank credit risk volatility after the collapse of Lehman Brothers. The main implication is that, in crisis times, a sufficiently flexible operational framework for monetary policy implementation produces the most timely response to market tensions.

Suggested Citation

Beirne, John and Caporale, Guglielmo Maria and Spagnolo, Nicola, Liquidity Risk, Credit Risk and the Overnight Interest Rate Spread: A Stochastic Volatility Modelling Approach (December 2013). The Manchester School, Vol. 81, Issue 6, pp. 925-940, 2013. Available at SSRN: https://ssrn.com/abstract=2339383 or http://dx.doi.org/10.1111/j.1467-9957.2012.02330.x

John Beirne (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Guglielmo Maria Caporale

Brunel University London - Department of Economics and Finance ( email )

Kingston Lane
Marie Jahoda Building
Uxbridge, Middlesex UB8 3PH
United Kingdom
+44 1895 266713 (Phone)
+44 1895 269770 (Fax)

HOME PAGE: http://www.brunel.ac.uk/about/acad/bbs/bbsstaff/ef_staff/guglielmocaporale/

London South Bank University ( email )

Centre for Monetary and Financial Economics
London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstraße 58
Berlin, 10117
Germany

Nicola Spagnolo

Brunel University London - Economics and Finance ( email )

Uxbridge UB8 3PH
United Kingdom

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