| dc.description.abstract | The failure of the interbank market to redistribute liquidity became a key feature of the financial crisis of 2007-2009. Unsecured money market risk premiums, henceforth risk premiums, increased sharply with the financial turmoil that began unfolding in august 2007. Risk premiums turned more volatile and interbank interest rates were divorced from the key policy rate of the central bank, except in maybe the shortest of maturities like overnight. After the default of Lehman Brothers in September 2008 risk premiums increased to even higher levels, exceeding the previous levels in the period from August 2007 until mid- September 2008. Evidence suggests banks were hoarding liquidity and activity in the interbank market seized up at over the shortest term lengths. The extremely high premium levels and the liquidity hoarding caused a serious threat to the financial system, as interbank markets are vital for bank’s liquidity management and the implementation of monetary policy. Also, disturbances in interbank markets has consequences for the wider economy as the interbank interest rates determines rates on loans and securities for household and non-financial firms, and thus the availability of credit for the economy as a whole.
The financial turbulence starting from august 2007 influenced the perception of risk in the interbank market and causing the risk premiums to rise. The aim of this master thesis is to investigate which types of risk and possibly other factors contributed to the relatively high money market risk premiums. Increased risk premiums were observed in several markets under different currency regimes during the financial crisis, particularly in the Western economies. Furthermore, due to the origin of the crisis was in the United States financial markets and European banks held high US dollar assets holdings prior to the crisis; it is possible that spill-over effects from the USD money market had a positive and severe impact on risk premiums in money markets in other currency regimes. This master thesis attempts to decompose the risk premium into different components reflecting credit risk, liquidity funding risk and US money market contagion. In order to do so regression techniques will be applied. The risk premium of interbank markets in United States, Great Britain, Euro-Area, Norway, Sweden, Canada and Australia are investigated. Risk premiums contained in 3-month interbank lending and borrowing will be used in the econometric modeling. 3-month maturity is the most commonly used maturity in studies of similar nature (ECB 2008).
The econometric models will cover three separated parts. The first period will represent normal conditions in the interbank market. The crisis phase will be divided into two parts, with the Lehman Brothers collapse splitting the two. I believe it is of interest to make a division at the point of the Lehman Brothers bankruptcy for several reasons. Immediately after the collapse we observe a substantial increase in the all risk premiums in question, reaching the highest levels under the crisis. Further, following the collapse of Lehman Brothers, banks were hoarding liquidity as from the last part of September. The idea is to investigate whether key drivers of the risk premiums altered during the crisis. The Engle-Granger method and autoregressive distributed lag models are used to serve the purpose.
The analysis from econometric results offer some evidence of the importance of credit default risk, liquidity funding risk, expected exchange rate risk and influence from the USD interbank market tensions to explain the increasing risk premium in interbank markets during the financial crisis. The influence of credit default and liquidity funding risk seems to have altered with the fall of Lehman Brothers. From only significance in few markets in the first part, the situation is quite different after mid-September 2008. Further, the results indicate that spillover effects from the US money market were consistent during the course of the crisis. The last part of the crisis can be characterized by cointegration; hence the variables are long-run dependent. The USD interbank market is found weakly exogenous, suggesting fairly strongly that the US influence went in a one way direction. | eng |