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Optimal pricing of intraday liquidity

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  • Martin, Antoine

Abstract

It is a puzzling fact that many central banks choose to lend intra-day funds at an interest rate of zero (or very close to zero), while the interest rate on overnight funds is much higher. I build a general equilibrium model where intra-day liquidity is needed because it is costly to make precise the time at which payments are received. If liquidity shocks are uninsurable, a necessary and sufficient condition for an equilibrium to be efficient is that the nominal intra-day interest rate be zero. This is true despite the fact that the overnight nominal rate is strictly positive (the reverse of the discount factor). Since a market intra-day rate will not always be zero, this creates a role for the central bank to supply intra-day liquidity. I allow for the possibility of moral hazard and study policies commonly used by central banks to reduce their exposure to risk. I show that collateralized lending achieves the efficient allocation, while, for certain parameters, caps on borrowing cannot prevent moral hazard.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 51 (2004)
Issue (Month): 2 (March)
Pages: 401-424

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Handle: RePEc:eee:moneco:v:51:y:2004:i:2:p:401-424

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Web page: http://www.elsevier.com/locate/inca/505566

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