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On the pervasive effects of Federal Reserve settlement regulations

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  • Ken B. Cyree
  • Mark D. Griffiths
  • Drew B. Winters
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    Abstract

    To manage their reserve positions, depository institutions in the United States actively buy and sell deposits at the Federal Reserve Banks via the federal funds market. Beginning in 1991, the Eurodollar market also became an attractive venue for trading deposits at the Federal Reserve Banks. Prior to 1991, the Federal Reserve’s statutory reserve requirement on Eurocurrency liabilities of U.S. banking offices discouraged use of Eurocurrency liabilities as a vehicle for trading deposits at the Federal Reserve. This impediment was removed in December 1990. Beginning in January 1991, the overnight instruments in the federal funds market and in the Eurodollar markets, except for minor differences in risk, became similar vehicles for exchanging deposits at Federal Reserve Banks. Because the risk characteristics of the instruments differ, the law of one price need not hold precisely across the two markets. Yet, the authors hypothesize that, beginning in 1991, the two trading instruments became close enough substitutes that price pressures in one market began to show through to the other. Herein, the authors examine overnight LIBOR for U.S. bank settlement effects. During the period when the federal funds market and Eurodollar markets are similar venues for trading deposits at Federal Reserve Banks, they find strong settlement effects in overnight LIBOR. However, during the period when Eurocurrency liabilities carry a reserve tax, they find no evidence of a settlement effect in overnight LIBOR. Their results suggest that (i) the microstructure of the federal funds market spills over into the markets for substitute assets and (ii) Federal Reserve rules have implications beyond U.S. borders.

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    Bibliographic Info

    Article provided by Federal Reserve Bank of St. Louis in its journal Review.

    Volume (Year): (2003)
    Issue (Month): Mar ()
    Pages: 27-46

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    Handle: RePEc:fip:fedlrv:y:2003:i:mar:p:27-46:n:v.85no.2

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    Keywords: Federal funds market (United States) ; Euro-dollar market ; Money market funds;

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Hamilton, James D, 1996. "The Daily Market for Federal Funds," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 104(1), pages 26-56, February.
    2. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, Elsevier, vol. 52(1-2), pages 5-59.
    3. Cyree, Ken B & Winters, Drew B, 2001. "Analysis of Federal Funds Rate Changes and Variance Patterns," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 24(3), pages 403-18, Fall.
    4. Ray Chou & Robert F. Engle & Alex Kane, 1991. "Measuring Risk Aversion From Excess Returns on a Stock Index," NBER Working Papers 3643, National Bureau of Economic Research, Inc.
    5. Ken B. Cyree & Drew B. Winters, 2001. "Analysis Of Federal Funds Rate Changes And Variance Patterns," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 24(3), pages 403-418, 09.
    6. Glosten, Lawrence R & Jagannathan, Ravi & Runkle, David E, 1993. " On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks," Journal of Finance, American Finance Association, American Finance Association, vol. 48(5), pages 1779-1801, December.
    7. Leonardo Bartolini & Giuseppe Bertoli & Alessandro Prati, 2000. "Banks' Reserve Management, Transaction Costs, and the Timing of Federal Reserve Intervention," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 0123, Econometric Society.
    8. Joshua N. Feinman, 1993. "Reserve requirements: history, current practice, and potential reform," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), Board of Governors of the Federal Reserve System (U.S.), issue Jun, pages 569-589.
    9. Daniel L. Thornton, 1988. "The borrowed-reserves operating procedures: theory and evidence," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Jan, pages 30-54.
    10. Marvin Goodfriend & Monica Hargraves, 1983. "A historical assessment of the rationales and functions of reserve requirements," Economic Review, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue Mar, pages 3-21.
    11. Griffiths, Mark D. & Winters, Drew B., 1995. "Day-of-the-week effects in federal funds rates: Further empirical findings," Journal of Banking & Finance, Elsevier, Elsevier, vol. 19(7), pages 1265-1284, October.
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    Cited by:
    1. Daniel L. Thornton, 2007. "Open market operations and the federal funds rate," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Nov, pages 549-570.
    2. Leonardo Bartolini & Spence Hilton & Alessandro Prati, 2005. "Money market integration," Staff Reports, Federal Reserve Bank of New York 227, Federal Reserve Bank of New York.
    3. Kotomin, Vladimir & Winters, Drew B., 2007. "The impact of the return to lagged reserve requirements on the federal funds market," Journal of Economics and Business, Elsevier, Elsevier, vol. 59(2), pages 111-129.
    4. Selva Demiralp & Brian Preslopsky & William Whitesell, 2004. "Overnight interbank loan markets," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2004-29, Board of Governors of the Federal Reserve System (U.S.).
    5. Selva Demiralp & Dennis Farley, 2003. "Declining required reserves, funds rate volatility, and open market operations," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2003-27, Board of Governors of the Federal Reserve System (U.S.).
    6. Kotomin, Vladimir & Smith, Stanley D. & Winters, Drew B., 2008. "Preferred habitat for liquidity in international short-term interest rates," Journal of Banking & Finance, Elsevier, Elsevier, vol. 32(2), pages 240-250, February.

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