An early warning indicator for liquidity shortages in the interbank market

Andrea Eross, Andrew Urquhart, Simon Wolfe

Research output: Contribution to journalArticle

Abstract

The financial crisis of 2007-08 is recognised to be the worst crisis since the Great Depression of the 1930s and as a result, liquidity risk in the interbank market has gained increased attention. The main objective of this study is to investigate 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 of different levels reveal regime changes consistent with liquidity crashes. The transition between the states is time and 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 striking the interbank market.
LanguageEnglish
JournalInternational Journal of Finance and Economics
StateAccepted/In press - 30 Dec 2018

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Shortage
Liquidity
Early warning
Interbank market
Crash
Gibbs sampler
Structural breaks
Random walk
Liquidity risk
Financial crisis
Persistence
Regime-switching model
Regime change
Great Depression

Cite this

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An early warning indicator for liquidity shortages in the interbank market. / Eross, Andrea; Urquhart, Andrew; Wolfe, Simon.

In: International Journal of Finance and Economics, 30.12.2018.

Research output: Contribution to journalArticle

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