What Interbank Rates Tell Us About Time-Varying Disaster Risk

We characterize time-varying disaster risk using interbank rates and their options. The identification of disaster risk has remained a significant challenge due to the rarity of macroeconomic disasters. We make an identification assumption that macroeconomic disasters coincide with banking disasters -- extremely unlikely events in which the interbank market fails and investors suffer significant losses. Based on our flexible reduced-form setup, interbank rates together with their options allow us to extract the short-run and long-run components of disaster risk. Our estimation results serve as an external validity test of rare disaster models, which are typically calibrated to match stock moments.