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The Transmission Mechanism of Stress in the International Banking System

Author

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  • Alexis Stenfors

    (University of Portsmouth)

  • Lilian Muchimba

    (University of Portsmouth)

Abstract

Significant and volatile deviations from the covered interest parity (CIP) are indicators of stress in the international banking system. This paper uses a TVP-VAR model to investigate the dynamic connectedness and spillovers of such stress between the US, the UK, Japan and the Eurozone from 4 July 2006 to 9 June 2022. To do so, we use daily price data on cross-currency basis swaps (CRSs), typically used to trade and express CIP deviations for maturities of 1 year and beyond. We also incorporate a yield curve dimension by including prices representative of the short-term (1Y), medium-term (5Y) and long-term (10Y) to obtain a more nuanced picture of the role of market expectations. Our findings suggest that overall connectedness is highly event-dependent and peaks during periods of high volatility and market stress. However, the transmission mechanism across banking systems and yield curve maturities has evolved considerably over time, which has significant implications for policies attempting to mitigate future crises.

Suggested Citation

  • Alexis Stenfors & Lilian Muchimba, 2023. "The Transmission Mechanism of Stress in the International Banking System," Working Papers in Economics & Finance 2023-03, University of Portsmouth, Portsmouth Business School, Economics and Finance Subject Group.
    • Handle: RePEc:pbs:ecofin:2023-03
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    References listed on IDEAS

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    More about this item

    Keywords

    Banks; CIP deviations; Cross-currency basis swaps; Dynamic connectedness; TVP-VAR; Yield curves;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • F3 - International Economics - - International Finance
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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