Options on Interbank Rates and Implied Disaster Risk

48 Pages Posted: 23 Oct 2019 Last revised: 17 Apr 2023

See all articles by Hitesh Doshi

Hitesh Doshi

University of Houston - C.T. Bauer College of Business

Hyung Joo Kim

Board of Governors of the Federal Reserve System

Sang Byung Seo

University of Wisconsin - Madison

Multiple version iconThere are 2 versions of this paper

Date Written: October 13, 2019

Abstract

The identification of disaster risk has remained a significant challenge due to the rarity of macroeconomic disasters. We show that the interbank market can help characterize the time variation in disaster risk. We propose a risk-based model in which macroeconomic disasters are likely to coincide with interbank market failure. Using interbank rates and their options, we estimate our model via MLE and filter out the short-run and long-run components of disaster risk. Our estimation results are independent of the stock market and serve as an external validity test of rare disaster models, which are typically calibrated to match stock moments.

Keywords: economic disasters, time-varying disaster risk, interbank rates, interbank rate options, maximum likelihood estimation, extended Kalman filter

JEL Classification: G12, G13, C13, C58

Suggested Citation

Doshi, Hitesh and Kim, Hyung Joo and Seo, Sang Byung, Options on Interbank Rates and Implied Disaster Risk (October 13, 2019). Available at SSRN: https://ssrn.com/abstract=3469087 or http://dx.doi.org/10.2139/ssrn.3469087

Hitesh Doshi

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

Hyung Joo Kim

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Sang Byung Seo (Contact Author)

University of Wisconsin - Madison ( email )

975 University Avenue
Madison, WI 53706-1324

HOME PAGE: http://sites.google.com/site/sangbyungseo

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