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An early warning indicator for liquidity shortages in the interbank market

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  • Andrea Eross
  • Andrew Urquhart
  • Simon Wolfe

Abstract

This study investigates 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, which delimit four intensities, reveals regime changes consistent with liquidity crashes. The transition between the states is state dependent, and the posterior estimates for the crisis and noncrisis 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 impacting the interbank market.

Suggested Citation

  • Andrea Eross & Andrew Urquhart & Simon Wolfe, 2019. "An early warning indicator for liquidity shortages in the interbank market," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 24(3), pages 1300-1312, July.
    • Handle: RePEc:wly:ijfiec:v:24:y:2019:i:3:p:1300-1312
    DOI: 10.1002/ijfe.1719
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    Cited by:

    1. Vishwesha Guttal & Srinivas Raghavendra & Nikunj Goel & Quentin Hoarau, 2016. "Lack of Critical Slowing Down Suggests that Financial Meltdowns Are Not Critical Transitions, yet Rising Variability Could Signal Systemic Risk," PLOS ONE, Public Library of Science, vol. 11(1), pages 1-20, January.

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