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Options on Interbank Rates and Implied Disaster Risk
Published online by Cambridge University Press: 08 August 2025
Abstract
The identification of disaster risk has remained a significant challenge due to the rarity of macroeconomic disasters. We show that the interbank market can help characterize the time variation in disaster risk. We propose a risk-based model in which macroeconomic disasters are likely to coincide with interbank market failure. Using interbank rates and their options, we estimate our model via maximum likelihood estimation (MLE) and filter the short-run and long-run components of disaster risk. Our estimation results are independent of the stock market and serve as an external validity test of rare disaster models, which are typically calibrated to match stock moments.
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- Research Article
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- Copyright
- © The Author(s), 2025. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington
Footnotes
We thank George Pennacchi (the editor) and the anonymous referee for their valuable comments and suggestions. We are also grateful to Caio Almeida, Hui Chen, Mathieu Fournier, Kris Jacobs, Mete Kilic, Praveen Kumar, Ivan Shaliastovich, Anders Trolle, Jessica Wachter, Nancy Xu, and seminar participants at the North American Summer Meeting of the Econometric Society, European Finance Association Annual Meeting, Northern Finance Association Conference, Financial Management Association Annual Meeting, and University of Houston for helpful comments. We gratefully acknowledge the financial support from the Canadian Derivatives Institute. The analysis and conclusions set forth are those of the authors and do not indicate concurrence by the Federal Reserve Board or other members of its staff. An earlier version of this manuscript was circulated under the title “What Interbank Rates Tell Us About Time-Varying Disaster Risk.”
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