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The authors can be contacted via e-mail. We thank Ravi Balakrishnan, Tim Bollershev, Markus Brunnermeier, John Kiff, Uli Klueh, Laura Kodres, Luc Laeven, Vance Martin, Paul Mills, Matt Pritsker, Kevin Sheppard, Francis Vitek, Etienne Yehoue, as well as conference participants at the Banque de France and Brunel University and seminar participants at the Catholic University in Rio de Janeiro, Chinese Academy of Social Sciences, Chinese University of Hong Kong, IMF and Oxford for suggestions and comments. Oksana Khadarina provided excellent research assistance.
The events that led to the U.S. subprime crisis are discussed in the IMF Global Financial Stability Report (2008).
The “on-the-run” Treasury note is usually the most recently issued of a particularly liquid maturity and is used for pricing other assets. An on-the-run Treasury bill becomes “off-the-run” when a new note is issued in that maturity bracket. Other alternative measures of overall market liquidity were also examined, including the spread between the 10-year and the 5-year on-the-run and off-the-run U.S. Treasury securities, and the spread between the 10-year U.S. Treasury bond and other less liquid maturities. Overall, the findings were broadly in line with the 2-year on-the-run spread. It should be noted though, as pointed out by Fleming (2003), that the various measures are imperfect proxies of U.S. Treasury market liquidity but that the 5-year and the 2-year note spreads showed the biggest increase during the 1998 LTCM crisis in response to a desire for investors to move to the most liquid assets. The high demand for 5 and 2-year Treasury notes for potential repurchases suggests this variable may capture some funding as well as market liquidity.
This variable was created by taking the unweighted daily average of the 5-year credit default swaps for the following institutions: Morgan Stanley, Merrill Lynch, Goldman Sachs, Lehman Brothers, JP Morgan, Deutsche Bank, Bank of America, Citigroup, Barclays, Credit Suisse, UBS, and Bear Sterns.
We initially estimated the CCC model as well but the assumption of constant conditional correlation among the variables of interest is not very realistic especially in times of stress where correlations can rapidly change. Therefore, the DCC model is a better choice since correlations are time-varying.
These are also presented in chapter 3 of the IMF Global Financial Stability Report (2008) on the subprime and credit crisis. In this paper, we use the on-the-run/off-the-run spread for the 2-year U.S. Treasury Bond, rather than the 5-year equivalent.
Since we do not want to impose a specific date for the hypothesized break at the end of July 2008, the linear approach allows us to capture a larger window of days for the structural break.