Interest Rate Risk Propagation: Evidence from the Credit Crunch

North American Journal of Economics and Finance, Vol. 28, p. 242-264, 2014

Posted: 12 Sep 2016

See all articles by Hsin-Feng Yang

Hsin-Feng Yang

Independent

Chih-Liang Liu

National Yunlin University of Science and Technology - Department of Finance

Ray Y. Chou

Academia Sinica

Date Written: April 10, 2014

Abstract

During the 2007–2009 financial crisis, US subprime mortgage risk exposures led to severe liquidity problems in several other foreign markets. Such risk contagion was caused by enormous changes in interest rates. Although risk contagion has been investigated by several literatures, the magnitude of propagated interest rate risk around global financial markets remains unexplored. Therefore, this study quantifies the degree to which the increased credit risk within the US financial system propagated to the European markets’ liquidity risks. Specifically, using a conditional value-at-risk (CoVaR) model, we quantitatively measure interest rate risk of a European country, by looking at the upside risk in distribution of changes in interest rate. And such propagation risk measure considers additional value-at-risk conditional on the interest rate movements in the US. The results show significantly positive differences between European country's value-at-risk conditional on the US financial markets being in a normal or distressed state. This propagating effect increased from 2007, and was particularly pronounced in the 2008–2009. In addition, the interest rate risk contagion is especially severe for some countries in the Euro regions with greater sovereign debt problems. Hence our result foretells the deterioration of the European sovereign debt crisis which started to unfold in 2010. Our work supplements the literature by successfully quantifying the magnitude of additional interest rate risk conditional on risk exposure from external sectors.

Keywords: Risk Contagion; CoVaR; Liquidity Risk; Credit Risk; Financial Crisis

JEL Classification: G01; G15; G21

Suggested Citation

Yang, Hsin-Feng and Liu, Chih-Liang and Chou, Ray Y., Interest Rate Risk Propagation: Evidence from the Credit Crunch (April 10, 2014). North American Journal of Economics and Finance, Vol. 28, p. 242-264, 2014, Available at SSRN: https://ssrn.com/abstract=2837166

Hsin-Feng Yang

Independent ( email )

Chih-Liang Liu (Contact Author)

National Yunlin University of Science and Technology - Department of Finance ( email )

Douliu City
Taiwan
+886 5 5342601 (Phone)

Ray Y. Chou

Academia Sinica ( email )

128 Academia Road, Section 2
Nankang
Taipei, 11529
Taiwan

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