An Early Warning Indicator for Liquidity Shortages in the Interbank Market

30 Pages Posted: 12 Sep 2015 Last revised: 29 Oct 2016

See all articles by Andrea Eross

Andrea Eross

Heriot-Watt University

Andrew Urquhart

ICMA Centre, Henley Business School

Simon Wolfe

University of Southampton - School of Management; University of Southampton - Southampton Business School

Date Written: September 29, 2015

Abstract

This study investigates an early warning indicator for liquidity shortages in the short-term interbank market. To identify structural breaks and their persistence, an autoregressive two-state regime switching model is presented. The variability in the LIBOR-OIS spread along with thresholds, which delimit four intensities, reveal regime changes consistent with liquidity crashes. The transition between the states is state dependent, and the posterior estimates for the crisis and non-crisis states are estimated using the Gibbs sampler. We forecast our early warning indicator up to December 2011 and show that the estimates are superior to a random walk with drift. Therefore, the model is an effective early warning indicator of an imminent liquidity shortage impacting the interbank market.

Keywords: interbank market, liquidity, financial crisis, regime switching, Bayesian

JEL Classification: C11, F37, G01

Suggested Citation

Eross, Andrea and Urquhart, Andrew and Wolfe, Simon, An Early Warning Indicator for Liquidity Shortages in the Interbank Market (September 29, 2015). Available at SSRN: https://ssrn.com/abstract=2658797 or http://dx.doi.org/10.2139/ssrn.2658797

Andrea Eross (Contact Author)

Heriot-Watt University ( email )

Mary Burton Building
School of Social Sciences
Edinburgh, Midlothian EH14 4AS
United Kingdom

Andrew Urquhart

ICMA Centre, Henley Business School ( email )

University of Reading
Whiteknights
Reading, Berkshire RG6 6BA
United Kingdom

Simon Wolfe

University of Southampton - School of Management ( email )

Highfield
Southampton S017 1BJ, Hampshire SO17 1BJ
United Kingdom

University of Southampton - Southampton Business School ( email )

Southampton, SO17 1BJ
United Kingdom

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