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Over-the-counter loans, adverse selection, and stigma in the interbank market

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  • Huberto Ennis

    (Federal Reserve Bank of Richmond)

  • John Weinberg

    (Federal Reserve Bank of Richmond)

Abstract

We study a model of interbank credit where physical and informational frictions limit the opportunities for intertemporal trade among banks and outside investors. Banks obtain loans in an over-the-counter market (involving search, bilateral matching, and negotiations over the terms of the loan) and hold assets of heterogeneous quality that in turn determine their ability to repay those loans. When asset quality is not observable by outside investors, information about the actions taken by a bank in the loan market may influence prices in the asset market. In particular, under some conditions, borrowing from the central bank can be regarded as a negative signal about the quality of the borrower's assets and banks may be willing to borrow in the market at rates higher than the one offered by the central bank. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2012.09.005
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 16 (2013)
Issue (Month): 4 (October)
Pages: 601-616

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Handle: RePEc:red:issued:10-115

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Related research

Keywords: Discount window; Signaling; Search; Bargaining; Private information; Banking;

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References

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  1. Morten L. Bech & Elizabeth Klee, 2010. "The mechanics of a graceful exit: interest on reserves and segmentation in the federal funds market," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2010-07, Board of Governors of the Federal Reserve System (U.S.).
  2. Leonardo Bartolini & Svenja Gudell & Spence Hilton & Krista Schwarz, 2005. "Intraday trading in the overnight federal funds market," Current Issues in Economics and Finance, Federal Reserve Bank of New York, Federal Reserve Bank of New York, vol. 11(Nov).
  3. Allen, Franklin & Carletti, Elena & Gale, Douglas, 2009. "Interbank market liquidity and central bank intervention," Journal of Monetary Economics, Elsevier, Elsevier, vol. 56(5), pages 639-652, July.
  4. Furfine, Craig, 2003. "Standing Facilities and Interbank Borrowing: Evidence from the Federal Reserve's New Discount Window," International Finance, Wiley Blackwell, Wiley Blackwell, vol. 6(3), pages 329-47, Winter.
  5. Thomas B. King, 2008. "Discipline and Liquidity in the Interbank Market," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 40(2-3), pages 295-317, 03.
  6. Flannery, Mark J, 1996. "Financial Crises, Payment System Problems, and Discount Window Lending," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 28(4), pages 804-24, November.
  7. Furfine, Craig, 2001. "The reluctance to borrow from the Fed," Economics Letters, Elsevier, Elsevier, vol. 72(2), pages 209-213, August.
  8. Kim, Youngse, 2003. "Income distribution and equilibrium multiplicity in a stigma-based model of tax evasion," Journal of Public Economics, Elsevier, Elsevier, vol. 87(7-8), pages 1591-1616, August.
  9. Leland, Hayne E & Pyle, David H, 1977. "Informational Asymmetries, Financial Structure, and Financial Intermediation," Journal of Finance, American Finance Association, American Finance Association, vol. 32(2), pages 371-87, May.
  10. Thomas Philippon & Vasiliki Skreta, 2012. "Optimal Interventions in Markets with Adverse Selection," American Economic Review, American Economic Association, American Economic Association, vol. 102(1), pages 1-28, February.
  11. Darrell Duffie & Nicolae Garleanu & Lasse Heje Pedersen, 2005. "Over-the-Counter Markets," Econometrica, Econometric Society, Econometric Society, vol. 73(6), pages 1815-1847, November.
  12. Stavros Peristiani, 1998. "The Growing Reluctance To Borrow At The Discount Window: An Empirical Investigation," The Review of Economics and Statistics, MIT Press, vol. 80(4), pages 611-620, November.
  13. Xavier Freixas & José Jorge, 2008. "The Role of Interbank Markets in Monetary Policy: A Model with Rationing," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 40(6), pages 1151-1176, 09.
  14. Andrea L. Eisfeldt, 2004. "Endogenous Liquidity in Asset Markets," Journal of Finance, American Finance Association, American Finance Association, vol. 59(1), pages 1-30, 02.
  15. Xavier Freixas & Antoine Martin & David Skeie, 2009. "Bank liquidity, interbank markets, and monetary policy," Staff Reports, Federal Reserve Bank of New York 371, Federal Reserve Bank of New York.
  16. Artuç, Erhan & Demiralp, Selva, 2010. "Discount window borrowing after 2003: The explicit reduction in implicit costs," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(4), pages 825-833, April.
  17. Adam B. Ashcraft & Darrell Duffie, 2007. "Systemic Illiquidity in the Federal Funds Market," American Economic Review, American Economic Association, American Economic Association, vol. 97(2), pages 221-225, May.
  18. Freeman, Scott, 1996. "The Payments System, Liquidity, and Rediscounting," American Economic Review, American Economic Association, American Economic Association, vol. 86(5), pages 1126-38, December.
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Citations

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Cited by:
  1. Acharya, Viral V. & Fleming, Michael J. & Hrung, Warren B. & Sarkar, Asani, 2014. "Dealer financial conditions and lender-of-last resort facilities," Staff Reports, Federal Reserve Bank of New York 673, Federal Reserve Bank of New York.
  2. Afonso, Gara M. & Lagos, Ricardo, 2014. "Trade Dynamics in the Market for Federal Funds," Working Papers, Federal Reserve Bank of Minneapolis 710, Federal Reserve Bank of Minneapolis.
  3. Spence Hilton & James McAndrews, 2011. "Challenges and lessons of the Federal Reserve's monetary policy operations during the financial crisis," Chapters, European Central Bank, European Central Bank.
  4. repec:fip:fedreq:y:2011:i:4q:p:389-413:n:vol.97no.4 is not listed on IDEAS
  5. Itai Agur, 2014. "Bank Risk Within and Across Equilibria," IMF Working Papers, International Monetary Fund 14/116, International Monetary Fund.
  6. Hajime Tomura, 2012. "Asset Illiquidity and Market Shutdowns in Competitive Equilibrium," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(3), pages 283-294, July.

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