What Drives the Libor-OIS Spread? Evidence from Five Major Currency Libor-OIS Spreads

Abstract

As a banking system health indicator and risk premium, the Libor-OIS spread has attracted great interest during recent years. Despite the recent Libor fixing scandal, our study based on five major currencies can still shed insights on the true determinants of the Libor-OIS spreads under different market conditions. During the crisis period, the combined interest rate, the slope, the banking system leverage, the market liquidity risk and corporate bond market default risk are all shown to be predictive for both the level and the change of the Libor-OIS spreads. In addition, market volatility and the state of the economy are two strong predictors for the level of the Libor-OIS spread only. The systemic distress and default risk and counterparty risk are strongly related to the changes in the spread. Further analysis based on the USD spread factor also reveals that business oriented reasons are also related to the spread movement.