An Early Warning Indicator for Liquidity Shortages in the Interbank Market
30 Pages Posted: 12 Sep 2015 Last revised: 29 Oct 2016
Date Written: September 29, 2015
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: Suggested Citation