US Treasury market default risk and global interbank liquidity risk

Abstract

Using Credit Default Swaps (CDS) on sovereign bonds, we investigate whether US sovereign default risk is a greater driving factor of domestic interbank funding risk than domestic sovereign default risk across the five Libor counties including Canada and Australia. We use equivalent-country interbank LIBOR-OIS spreads as a proxy for domestic interbank funding risk. Our results show evidence of US sovereign default-risk spillover into global interbank funding markets and that domestic sovereign default risk may not always drive equivalent-home-country interbank funding risk. Our analysis provides important insights into the channels through which sovereign default risk can impact financial stability.