Overnight Borrowing, Interest Rates and Extreme Value Theory
26 Pages Posted: 13 Sep 2004
Date Written: November 2001
We examine the dynamics of extreme values of overnight borrowing rates in an inter-bank money market before a financial crisis during which overnight borrowing rates rocketed up to (simple annual) 4000 percent. It is shown that the generalized Pareto distribution fits well to the extreme values of the interest rate distribution. We also provide predictions of extreme overnight borrowing rates before the crisis. The examination of tails (extreme values) provides answers to such issues as what are the extreme movements expected in financial markets; have we already seen the largest moves; is there a possibility for even larger movements and, are there theoretical processes that can model the type of fat tails in the observed data? The answers to such questions are essential for proper management of financial exposures and laying ground for regulations.
Keywords: Financial crises, risk management, extreme value theory, overnight rate, federal funds
JEL Classification: G0, G1, C1
Suggested Citation: Suggested Citation