The Federal Reserve recently released a research paper entitled, "Modeling Money Market Spreads: What Do We Learn about Refinancing Risk?." The abstract of the 48-page report says, "We quantify the effect of refinancing risk on euro area money market spreads, a major factor driving spreads during the financing crisis. With the advent of the crisis, market participants' perception of their ability to refinance over a given period of time changed radically. As a result, borrowers preferred to obtain funding for longer tenors and lenders were willing to provide funding for shorter tenors. This discrepancy resulted in a need to refinance more frequently in order to borrow over a given horizon, thus increasing refinancing risk. We measure refinancing risk by quantifying the sensitivity of the spread to the refinancing frequency. In order to do so we introduce a model to price EURIBOR-based money market spreads vis-a-vis the overnight index swap.... Results suggest that refinancing risk affects the spread significantly across time, albeit in a largely varying manner. Central bank interventions have reduced the spreads as well as the effect of refinancing risk on them." The conclusion adds, "This paper proposes a model that measures the effect of the frequency of refinancing on the spread. This is done by modeling the whole surface of observed Euribor-based money market spreads over all maturities and commitment periods ahead.... As the effect of the refinancing frequency on the spread increases, refinancing risk becomes more important in driving the spread. The importance of refinancing risk can vary over time."
