Modelling the Determinants of Overnight Index Swap and LIBOR-OIS Spread

The LIBOR – OIS spread is the difference between the London Interbank Offered Rate and the overnight index swap rate that reflects the measure of banks reliance to each other within the particular period. It was a close-to-zero measure with little volatility at the beginning of the XXI century. With its unexpected growth at the start of the financial crisis of 07-08 the spread determination has become the issue of high interest. The standard approach to its decomposition is to divide between credit risk and non-credit risk premiums. It is the Bank of England that suggested it assuming the OIS rate as a risk-free proxy. Relaxing this assumption, this work provides the OIS rate specifications that result in the presence of OIS premium. With the support of this specification the modified LIBOR – OIS spread decomposition is offered in the work. The analysis is based on the daily data of 3-month, British pound OIS rate and LIBOR – OIS spread. The period under consideration is from 2007 to 2012. It is chosen with the willing to capture the OIS premium effect within the crisis since the behavior of the spread is crucial in determination of the interbank financing conditions in the circumstances of high volatility. The after-crisis segment is also taken into account and the final specification distinguishes between OIS premiums during these different subperiods.