Euro Money Market Spreads During the 2007-? Financial Crisis

Nuno Cassola, Claudio Morana
2011 Social Science Research Network  
In the paper we investigate the empirical features of euro area money market turbulence during the recent ...nancial crisis. By means of a novel Fractionally Integrated Heteroskedastic Factor Vector Autoregressive model, we ...nd evidence of a deterministic level factor in the EURIBOR-OIS (OIS) spreads term structure, associated with the two waves of stress in the interbank market, following the BNP Paribas (9 August 2007) and the Lehman Brothers (16 September 2008) "shocks", and two additional
more » ... factors, of the long memory type, bearing the interpretation of curvature and slope factors. The unfolding of the crisis yielded a signi...cant increase in the persistence and volatility of OIS spreads. We also ...nd evidence of a declining trend in the level and volatility of OIS spreads since December 2008, associated with ECB interest rate cuts and full allotment policy. Key words: money market interest rates, credit/liquidity risk, fractionally integrated heteroskedastic factor vector autoregressive model. JEL classi...cation: C32, E43, E58, G15. NON-TECHNICAL SUMMARY In this paper we carry out an econometric analysis of the term structure of euro EURIBOR-OIS interest rate spreads. The data set is composed of daily data covering fifteen EURIBOR-OIS spreads, ranging from the oneweek maturity to the one-year maturity. The sample runs from 20 June 2005 to 7 April 2009 (992 days). The econometric analysis is done in several steps. The first step consists in testing for structural breaks in the means and variances (volatility) of the EURIBOR-OIS spreads. We find three break-points in the mean levels of the EURIBOR-OIS spreads, with similar location across maturities. The first break-point is located between is the day the French bank BNP Paribas revealed its inability to value structured products for two of its investment funds exposed to U.S. sub-prime mortgage risk, which were then closed. 16 September 2008 is the day after the bankruptcy of the American investment bank Lehman Brothers. These two break-points are economically intuitive. The third break-point follows the announcement, on 4 December 2008, of a 75 basis points (b.p.) decrease in key ECB policy rates, implemented on 10 December 2008. The location of this break-point is less intuitive from an economic point of view given that the ECB implemented a sequence of reductions in its key policy rates during the period The second step consists in testing for long-memory in the means and variances (volatility) of the breakfree EURIBOR-OIS spreads. Due to the breaks in the means and variances of the EURIBOR-OIS spreads, testing for long-memory is done for the break-free series, standardised according to the selected regimes for their variances. A cubic spline smoother is applied to the estimated break processes in order to yield smooth transitions across regimes. We find significant long-memory in the standardised break-free series which increases with maturity up to the three-week horizon, decreasing thereafter. However, similar persistence can be found for consecutive maturities. We find significant instability in the estimated persistence parameter when computed separately for the pre-crisis and crisis periods. These econometric results suggest that, after a shock, the EURIBOR-OIS spreads do not return to their (regime-changing) unconditional means as quickly as a meanreverting process would.
doi:10.2139/ssrn.1604694 fatcat:knlzjcf33jaybdghlmhr5jaqs4