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Estimating the money market microstructure with negative and zero interest rates

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  • Edoardo Rainone
  • Francesco Vacirca

Abstract

The Furfine [The microstructure of the federal funds market. Financ. Markets Inst. Instrum., 1999, 8(5), 24–44] algorithm is a key tool for researchers in monetary economics and central banking because it allows identification of the interbank money market microstructure. Furfine's method has been used in numerous studies of money markets but little work has examined how valid its application is at zero and negative interest rates. This work seeks to address this gap. We first extend the standard algorithm to include negative rates and show the bias introduced by the zero interest rate. Secondly, we propose a econometric procedure based on market regularities and the economic likelihood of interbank bilateral relationships to correct the bias. Thirdly, the methodology is applied to TARGET2 data. The impacts of recent monetary policy decisions on key interest rates are studied. We find significantly biased figures when the market microstructure is not correctly estimated.

Suggested Citation

  • Edoardo Rainone & Francesco Vacirca, 2020. "Estimating the money market microstructure with negative and zero interest rates," Quantitative Finance, Taylor & Francis Journals, vol. 20(2), pages 207-234, February.
    • Handle: RePEc:taf:quantf:v:20:y:2020:i:2:p:207-234
    DOI: 10.1080/14697688.2019.1665703
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    Cited by:

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    2. Thibaut Piquard & Dilyara Salakhova, 2019. "Secured and Unsecured Interbank Markets: Monetary Policy, Substitution and the Cost of Collateral," Working papers 730, Banque de France.
    3. Edoardo Rainone, 2017. "Pairwise trading in the money market during the European sovereign debt crisis," Temi di discussione (Economic working papers) 1160, Bank of Italy, Economic Research and International Relations Area.
    4. Ronald Heijmans & Richard Heuver & Zion Gorgi, 2016. "How to monitor the exit from the Eurosystem's unconventional monetary policy: Is EONIA dead and gone?," DNB Working Papers 504, Netherlands Central Bank, Research Department.
    5. Müller, Alexander & Paulick, Jan, 2020. ""The devil is in the details, but so is salvation": Different approachesin money market measurement," Discussion Papers 66/2020, Deutsche Bundesbank.

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    More about this item

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General

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