Lesson of the Day: The TED Spread
Posted by themarketanalyst on November 12, 2008
In times of financial crisis, economists look for indicators that attempt to measure credit risk or as some call it, the “fear factor.”
Lately, many references are made to the TED Spread and this posts attempts to look deeper into this indicator. Wikipedia defines the TED spread as the difference between the interest rates on interbank loans and short-term U.S. government debt (“T-bills”).
The TED spread is caculated as the difference between the 3month T-bill interest rate and the three month LIBOR. The 3 month T-bill is considered to be practically risk-free since it is backed by the good faith of the U.S. government. The LIBOR reflects the credit risks between commercial banks lending to each other. Therefore, the difference could be considered a risk premium.
Historically, the TED spread was 0.3% on average. This number increased during the credit crisis with a spike in September and then again to more than 4 in October 2008! Large international banks were previously considered almost as risk-free as the U.S treasury, but now we see how banks have become fearful of lending to each other.
‘Ted Spread’ Reflects Rise in Global Anxiety
Similarly, the following blog post points out a spike in the difference between the overnight Libor rate and the fed funds target rate, the concept is the same: Econbrowser: Understanding the TED spread
