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Post-Crisis Interest Rates: XIBOR Mechanics and Basis Spreads

This article presents a structural model for interbank money market rates (XIBOR rates) that endogenously generates the basis spreads that characterize post-crisis fixed income markets: XIBOR-OIS spreads, tenor basis spreads, and the forward basis. In contrast to existing multi-curve models, which impose basis spreads exogenously, our approach is based on a fundamental model for interbank cash transactions and the relevant credit and liquidity risk factors. Our framework thus offers a consistent arbitrage-free explanation for the emergence of basis spreads and multiple term structures and provides a theoretical underpinning of reduced-form multi-curve models. Our results demonstrate that the model calibrates well to pre- and post-crisis market data. We also show that funding liquidity is a key determinant of post-crisis XIBOR rates and, in particular, tenor basis spreads.