An International Examination of the Role of Default and Liquidity Risks in the Interbank Market.

38 Pages Posted: 19 Aug 2016

See all articles by Nikolaos Karouzakis

Nikolaos Karouzakis

University of Sussex; University of Sussex - School of Business, Management and Economics

John Hatgioannides

City University London - Sir John Cass Business School

Date Written: August 18, 2016

Abstract

We estimate a no-arbitrage model of the term structure of international interbank spreads, and attempt to disentangle credit and liquidity risk premium in the interbank market. We study the consistency of the spreads’ movements across major currencies and assess the effectiveness of monetary policy actions on the deterioration of credit and liquidity risks. We find that at the core of the financial crisis, the interbank spread is clearly driven by liquidity risk. The effect is stronger in the US market, where liquidity pressures were severe. Our analysis suggests that the establishment of the unconventional policy programs, led to the deterioration of liquidity risk in the interbank market. Furthermore, the policy of major Central banks to substantially cut interest rates, kept credit pressures at low levels. By early 2009, the dominant driver of the spread is credit risk. This effect is stronger in the Euro and UK markets, due to the escalation of the European sovereign debt crisis. This is not the case for the Japanese market, which experienced remarkably low credit pressures during the core of the crisis. Moreover, we decompose the spread into an expectation hypothesis component and a time-varying risk premia component and find that the hypothesis of constant risk premia is rejected.

Keywords: Interbank Market, Credit Risk, Liquidity Risk, LOIS Spread, Risk Premium

JEL Classification: E43, E58, G12, G15, C11

Suggested Citation

Karouzakis, Nikolaos and Hatgioannides, John, An International Examination of the Role of Default and Liquidity Risks in the Interbank Market. (August 18, 2016). 29th Australasian Finance and Banking Conference 2016. Available at SSRN: https://ssrn.com/abstract=2825962 or http://dx.doi.org/10.2139/ssrn.2825962

Nikolaos Karouzakis (Contact Author)

University of Sussex ( email )

Sussex House
Falmer
Brighton, Sussex BNI 9RH
United Kingdom

University of Sussex - School of Business, Management and Economics ( email )

Falmer, Brighton BN1 9SL
United Kingdom

John Hatgioannides

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

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