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A Black Swan in the Money Market

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  • John C. Williams
  • John B. Taylor

Abstract

The recent financial crisis saw a dramatic and persistent jump in interest rate spreads between overnight federal funds and longer - term interbank loans. The Fed took several actions to reduce these spreads including the creation of the Term Auction Facility (TAF). The effectiveness of these policies depends on the cause of the increased spreads such as counterparty risk, liquidity, or other factors. Using a no-arbitrage pricing framework and various measures of risk, we find robust evidence that increased counterparty risk contributed to the rise in spreads but do not find robust evidence that the TAF had a significant effect on spreads. (JEL E43, E44, E52, G21)

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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Journal: Macroeconomics.

Volume (Year): 1 (2009)
Issue (Month): 1 (January)
Pages: 58-83

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Handle: RePEc:aea:aejmac:v:1:y:2009:i:1:p:58-83

Note: DOI: 10.1257/mac.1.1.58
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  1. Joe Peek & Eric S. Rosengren, 1998. "Determinants of the Japan premium: actions speak louder than words," Working Papers 98-9, Federal Reserve Bank of Boston.
  2. Michael Melvin & Vincentiu Covrig & Buen Low, . "A Yen is not a Yen: TIBOR/LIBOR and the determinants of the 'Japan Premium'," Working Papers 2133360, Department of Economics, W. P. Carey School of Business, Arizona State University.
  3. Andrew Ang & Monika Piazzesi, 2001. "A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables," NBER Working Papers 8363, National Bureau of Economic Research, Inc.
  4. Vasco Curdia & Michael Woodford, 2008. "Credit Frictions and Optimal Monetary Policy," Discussion Papers 0809-02, Columbia University, Department of Economics.
  5. John P. Judd & John L. Scadding, 1982. "What do money market models tell us about how to implement monetary policy: reply," Working Papers in Applied Economic Theory 108, Federal Reserve Bank of San Francisco.
  6. Anderson, Richard G & Rasche, Robert H, 1982. "What Do Money Market Models Tell Us about How to Implement Monetary Policy?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 14(4), pages 796-828, November.
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