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The 2007 subprime market crisis through the lens of European Central Bank auctions for short-term funds

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Abstract

We study European banks’ demand for short-term funds (liquidity) during the summer 2007 subprime market crisis. We use bidding data from the European Central Bank’s auctions for one-week loans, their main channel of monetary policy implementation. Our analysis provides a high-frequency, disaggregated perspective on the 2007 crisis, which was previously studied through comparisons of collateralized and uncollateralized interbank money market rates which do not capture the heterogeneous impact of the crisis on individual banks. Through a model of bidding, we show that banks’ bids reflect their cost of obtaining short-term funds elsewhere (e.g., in the interbank market) as well as a strategic response to other bidders. The strategic response is empirically important: while a naïve interpretation of the raw bidding data may suggest that virtually all banks suffered an increase in the cost of short-term funding, we find that for about one third of the banks, the change in bidding behavior was simply a strategic response. We also find considerable heterogeneity in the short-term funding costs among banks: for over one third of the bidders, funding costs increased by more than 20 basis points, and funding costs vary widely with respect to the country-of-origin. Estimated funding costs of banks are also predictive of market- and accounting-based measures of bank performance, suggesting the external validity of our findings. JEL Classification: D44, E58, G01.

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1374.

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Length: 63 pages
Date of creation: Aug 2011
Date of revision:
Handle: RePEc:ecb:ecbwps:20111374

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Keywords: Multiunit auctions; primary market; structural estimation; subprime market; liquidity crisis.;

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References

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  1. Bindseil, Ulrich & Nyborg, Kjell G & Strebulaev, Ilya, 2004. "Bidding and Performance in Repo Auctions: Evidence from ECB Open Market Operations," CEPR Discussion Papers 4367, C.E.P.R. Discussion Papers.
  2. John C. Williams & John B. Taylor, 2009. "A Black Swan in the Money Market," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(1), pages 58-83, January.
  3. Arnold, Lutz G., 2005. "On the Possibility of Credit Rationing in the Stiglitz-Weiss Model," University of Regensburg Working Papers in Business, Economics and Management Information Systems 403, University of Regensburg, Department of Economics.
  4. Jens Eisenschmidt & Jens Tapking, 2009. "Liquidity risk premia in unsecured interbank money markets," Working Paper Series 1025, European Central Bank.
  5. Adam B. Ashcraft & Morten L. Bech & W. Scott Frame, 2008. "The Federal Home Loan Bank System: the lender of next-to-last resort?," Staff Reports 357, Federal Reserve Bank of New York.
  6. Christian Ewerhart & Nuno Cassola & Natacha Valla, 2007. "Declining Valuations And Equilibrium Bidding In Central Bank Refinancing Operations," Swiss Finance Institute Research Paper Series 07-22, Swiss Finance Institute.
  7. Jens Eisenschmidt & Astrid Hirsch & Tobias Linzert, 2009. "Bidding behaviour in the ECB's main refinancing operations during the financial crisis," Working Paper Series 1052, European Central Bank.
  8. Christian Ewerhart & Jens Tapking, 2008. "Repo markets, counterparty risk and the 2007/2008 liquidity crisis," Working Paper Series 909, European Central Bank.
  9. Breusch, T S & Pagan, A R, 1980. "The Lagrange Multiplier Test and Its Applications to Model Specification in Econometrics," Review of Economic Studies, Wiley Blackwell, vol. 47(1), pages 239-53, January.
  10. Kastl, Jakub, 2012. "On the properties of equilibria in private value divisible good auctions with constrained bidding," Journal of Mathematical Economics, Elsevier, vol. 48(6), pages 339-352.
  11. François-Louis Michaud & Christian Upper, 2008. "What drives interbank rates? Evidence from the Libor panel," BIS Quarterly Review, Bank for International Settlements, March.
  12. Ethan Cohen-Cole & Burcu Duygan-Bump & José Fillat & Judit Montoriol-Garriga, 2008. "Looking behind the aggregates: a reply to “Facts and Myths about the Financial Crisis of 2008”," Risk and Policy Analysis Unit Working Paper QAU08-5, Federal Reserve Bank of Boston.
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Cited by:
  1. Xavier Vives, 2009. "Strategic Supply Function Competition with Private Information," CESifo Working Paper Series 2856, CESifo Group Munich.
  2. Jason Allen & Ali Hortaçsu & Jakub Kastl, 2011. "Analyzing Default Risk and Liquidity Demand during a Financial Crisis: The Case of Canada," Working Papers 11-17, Bank of Canada.

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