The Impact of Subprime Mortgage Crisis on Cross-Currency Linkage of LIBOR-OIS Spreads

Abstract

This paper examines the cross-currency linkage of LIBOR-OIS spreads. We consider daily spread data in five major currencies for the period of March 1, 2006 to Nov 11, 2008. The impulse response analysis is conducted in a multivariate setting, adopting the bias-corrected bootstrap as a means of statistical inference. The overall evidence suggests that the crisis has substantially changed the nature of the cross-country interactions in liquidity premium. Global money markets fail to contain the US dollar term funding shocks and the role of Japanese yen in terms of liquidity source appears to be significant. Also the US dollar and yen spreads drive the cross-currency system of liquidity premium, whereas the premium in the euro, pound and Australian dollar funding equilibrate to errors in long-run relation of liquidity premium.

Keywords: Subprime mortgage crisis, LIBOR-OIS spreads, Vector autoregressive model, Cointegration, Vector error correction

JEL Classification: G15, C32