An early warning indicator for liquidity shortages in the interbank market: a regime switching approach

Andrea Eross, Andrew Urquhart, Simon Wolfe

    Research output: Contribution to conferencePaper

    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
    StateSubmitted - 8 Jul 2016

    Fingerprint

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

    Cite this

    @conference{0f5a4b48801c4d4ebe8aa35235bbd1ac,
    title = "An early warning indicator for liquidity shortages in the interbank market: a regime switching approach",
    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.",
    author = "Andrea Eross and Andrew Urquhart and Simon Wolfe",
    year = "2016",
    month = "7",
    day = "8",
    language = "English",

    }

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

    2016.

    Research output: Contribution to conferencePaper

    TY - CONF

    T1 - An early warning indicator for liquidity shortages in the interbank market: a regime switching approach

    AU - Eross,Andrea

    AU - Urquhart,Andrew

    AU - Wolfe,Simon

    PY - 2016/7/8

    Y1 - 2016/7/8

    N2 - 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.

    AB - 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.

    M3 - Paper

    ER -