Pricing factors in multiple-term structures from interbank rates

• Published in: Journal of international money and finance 2019-03, Vol.91, p.138-159
• Main Authors: Lafuente, Juan Ángel, Petit, Nuria, Serrano, Pedro
• Format: Article
• Language: English
• Subjects: Basis swaps; Default risk; Multiple-term structures
• ISSN: 0261-5606; 1873-0639
• DOI: 10.1016/j.jimonfin.2018.11.008

•We analyze the reward for the risk embedded in interbank derivatives.•Information of interbank risk premia is extracted from basis swap spreads.•Investors’ reward is linked to financial sector creditworthiness and liquidity.•A source of systematic risk priced in bond returns is attributable to interbank risk. This article analyzes the reward for the risk embedded in interbank derivatives, seeking to characterize the size and economic sources of the components of this risk premium in interbank spread quotes. The basis swap (BS) spreads – floating-to-floating interest rate swaps – are employed as a vehicle used by investors to express their views concerning the risk of borrowing on the interbank market. Our results show that the size of the risk premium ranges from 20 to 60 basis points, depending on the tenor, during periods of financial distress. Moreover, the evolution of this risk premium increases dramatically after August 2007, primarily due to the evolution of credit variables such as sovereign and financial sector risks. Finally, we also document important sources of commonality between risk premiums at different tenors. An analysis of the determinants of risk premia reveal that investors’ compensation relates to financial sector credit and liquidity uncertainty, and risk aversion.